Engineering a New Economy − Mike's Toolbox

Forty-four percent of Americans confess that they would be unable to raise $1,000 in the event of an emergency. Collectively we owe a record $1.13 trillion dollars to credit card companies, an average of about $6,000 each. The interest rate on these credit card balances approaches or even exceeds 30%! Meanwhile the U.S. government is weighed down by a massive $33 trillion dollar debt, twenty-two percent more than a full year of U.S. economic activity ($27T in 2023), and the debt grows every year. You might rightfully conclude that we're doing it wrong. In this article, you will not only see that we are doing it wrong, but you will learn to use some new tools to set up a thriving economy with lasting prosperity.

How to Fix the US Economy and the World

Fixing the US economy requires solving the dual problems of soaring debt for both the federal government and American households. The government debt increases every year because of a misunderstanding of how to react when tax revenue is less than government spending (known as a deficit). Economists and politicians constantly tweak the tax laws in an attempt to bring in more revenue to reduce the deficit, with the hope of balancing the budget (reducing the deficit to zero or even to create a budget surplus where more revenue is brought in above the amount spent by the government).

The Middle Class is the victim of the punishing tax code which has resulted from over a century of improperly set tax rates which are attempting to bring in more government revenue to eliminate the deficit.

The Middle Class, which was once thriving, now struggles living paycheck to paycheck and saddled with a huge debt burden because of a punishing tax code which attempts to achieve the unobtainable balanced budget.

The two major problems with the US economy are the surging national debt which increases every year, and a tax code which has destroyed the Middle Class, forcing many into borrowing on high-interest credit cards instead of being able to save for retirement. Fixing these problems will allow the government and citizens to pay off their debts over time

Two things need to happen to fix the dire position we're in. The federal government needs to reverse the trend of increasing the national debt and instead start paying it off, and the tax code needs to be adjusted so that the Middle Class (and everyone else) can be restored to prosperity

Fixing the situation will require reversing the trend of increasing debt, both for the US government and the population. Rebuilding the Middle Class involves providing enough prosperity so they can start paying off their credit card debt and eventually begin building their savings. The government needs to rethink how they react when there's a budget deficit, making it possible to pay off the debt instead of having it continually increase.

The surprisingly simple solution is to replace all federal taxes with a small percentage sales tax with a rate which decreases over time to only about 2%!

The US economy can be fixed by replacing all federal taxes with a national sales tax which starts at 14% and decreases over time to about 2%. (Undoing 110 years of deflation will require many years.) Although this page describes fixing the US economy, other economies of the world can emulate the US and also enjoy lasting prosperity.

In this analysis you will:

Table of Contents

Tax Flow Diagrams
   50% Federal Tax
      Currency Availability Multiplier (CAM)
   10% Federal Tax
   60% Federal Tax
   60% Federal Tax with Savings
   40% Federal Tax and 10% Local Tax
   10% Federal Tax and 10% Local Tax
   40% Federal Tax and 10% Imports
   No Federal Tax and 10% Imports

Forbes Tax Misery Index
   Original Misery Scores
   Enhanced Misery Scores

Choosing the Best Tax
   List of Available Taxes
   Tax Attributes
   Tax Comparison
   Sales Tax
   Personal Income Tax
   Corporate Income Tax
   Payroll Taxes
   Tax on Capital Gains and Interest
   Estate Tax
   Gift Tax
   Excise Taxes
   Value Added Tax (VAT)

Determining the Tax Rate
   The Laffer Curve
   Laffer Curve Flaw
   Modified Laffer Curve
   History of US Taxation
   US Taxation 1901 to Present
   US Taxation Before 1913
   US Taxation After 1913
   110 Years of Deflation
   A Return to Sanity
   The Long Term Fix

Tax Flow Diagrams

Understanding the economy has been an elusive goal of economists, politicians, and the general population. A new tool which sheds light on the workings of the economy is the Tax Flow Diagram. It illustrates how money circulates in the economy as it is spent on goods and services and as it gets taxed by the government. The simplest Tax Flow Diagram has just one parameter, the federal tax rate, which we'll adjust to see its effect on prosperity.

Although we'll see that it's way too high, let's initially set the tax rate to 50% to keep the math simple. The economy consists of a group of people willing to participate in transactions with each other but they start out with no money.

50% Federal Tax

The economy gets started when one of the people in the economy gets their paycheck for $1,000.

Tax Flow Diagram 50% First Transaction

With a tax rate of 50%, they pay $500 to the government and spend the remaining $500 on goods and services. At this point already half of the money has been removed from the economy. The remaining $500 ends up in the hands of other people in the economy who collectively pay $250 in tax and spend the remaining $250.

Tax Flow Diagram 50% Second Transaction

The $250 spent winds up as income for more people in the economy who pay $125 in tax and spend the remaining $125. At this point the government has collected $875 of the initial $1000 and with each new transaction there is less money circulating in the economy.

Tax Flow Diagram 50% Third Transaction

Eventually the entire $1000 has been collected by the government as tax, and a total of $2000 of economic activity has taken place.

Tax Flow Diagram 50%

This process is repeated throughout the economy. Everyone's paycheck gets taxed over and over again until there's no money left to make transactions. All of the money winds up in the hands of the federal government. So where does the initial $1000 come from? It must be from the federal government! The first person in the Tax Flow Diagram is either a government employee or receives money from the government such as by Social Security.

Currency Availability Multiplier (CAM)

The tax rate determines how much economic activity can take place. At 50%, we see that $1000 spent by the government leads to a total of $2000 in economic activity, a factor of 2, which is the reciprocal of the tax rate. This is called the Currency Availability Multiplier or CAM.

CAM = 1 ÷ TaxRate

With a CAM of 2, each $1000 of government spending yields just $2000 of economic activity, so if your economy is $26 trillion dollars, the government would need to spend at least $13 trillion to provide enough currency for all of the transactions people want to make. Obviously the government should not be this large, most economic activity occurs between non−government employees. Lowering the tax rate increases the CAM multiplier, so we can increase economic activity without any extra government spending.

When the tax rate is so high, there are skewed incentives. You earn $1000 but have to give half of it to the government. This means you gave your employer $1000 worth of work but only received half of your value. You're working twice as hard as you should need to.

10% Federal Tax

Now let's look at what happens when the tax rate is reduced to 10%. The initial $1000 salary in the Tax Flow Diagram results in a tax bill of just $100, leaving the person with $900 to spend on goods and services. The government might worry that they're not taxing enough since the rate was cut 80%. The common thought is that raising tax rates increases revenue and cutting tax rates reduces government revenue. But this is not the case, the government still collects the entire $1000 income, it just takes more transactions since the payments are smaller.

Tax Flow Diagram 10%

The amazing thing is how much more prosperous everyone is. The first person gets to keep $900 after paying their tax bill, an 80% increase over their income when the rate was 50%. The second person fares even better. Instead of $250, they retain $810, an increase of more than three times. Overall the total economic activity is $10,000, a five fold increase. The CAM multiplier is 10, the reciprocal of the tax rate. To achieve a $26 trillion dollar economy with a tax rate of 10%, the government just needs a budget of $2.6 trillion.

60% Federal Tax

Let's look at what happens when the tax rate is raised. The government might try raising the tax rate from 50% to 60% in an effort to increase revenue. We see from the Tax Flow Diagram that the initial $1000 paycheck leads to just $400 spending by the recipient, a decrease of 20%. The next person gives up $240 in tax and is left with just $160 in take−home pay, a reduction of 36%. It gets worse the further away you are from the first transaction.

Tax Flow Diagram 60%

Notice that the government still collects just $1000 since this is all there is! Raising the tax rate does not lead to more goverment revenue, it shrinks the economy. A 60% tax rate yields an economy with a CAM multiplier of 1 ÷ 0.6 = 1.667, a reduction of 17% from when the tax rate was 50%.

60% Federal Tax with Savings

But raising the tax rate does increase revenue, so let's look at why this happens. The economy was working well at 50% but the government raised the rate to 60%. The first person saw a reduction in take−home pay to $400 instead of $500. Their expenses are still $500 so they use $100 of their savings to make up the shortfall. The next person still earns $500 but they have to give $300 to the government instead of $250, so they pull $50 out of their savings as well.

Tax Flow Diagram 60% With Savings

Overall government revenue has increased 20% to $1200 and the total economic activity has remained at $2000, the same as it was when the tax rate was 50%. But this is unsustainable. The increased revenue is the result of people spending their savings, which will eventually run out, forcing people to cut back. Or worse, people need to use credit cards to supplement their after−tax income, with little prospect of being able to pay them off.

Too−high tax rates caused the Great Depression by depleting the savings of the middle and lower classes.

40% Federal Tax and 10% Local Tax

Let's investigate how state and local governments are affected by high federal tax rates. The first example is again a total tax rate of 50% with a split of 40% federal tax and 10% local tax. The Tax Flow Diagram works the same way as when the tax rate was 50%, but a fifth of the tax revenue goes to the local government. The same amount of economic activity occurs, $2000, with the federal government collecting $800 and the local government earning $200.

Tax Flow Diagram 40% Federal 10% Local

But this is not the end of the story. The local government is just another actor in the economy so they spend their $200 tax revenue which kicks off another copy of the Tax Flow Diagram with an initial salary of $200 instead of $1000. The economy adds an additional $400 of transactions while the federal government collects another $160 and local government gets $40. The process repeats with local government spending the $40 tax revenue.

Total economic activity is $2,500, the CAM multiplier is equal to 2.5 since the federal tax rate is 40%. The federal government collects the entire $1000 initial salary, while the local government raises $250.

10% Federal Tax and 10% Local Tax

Something amazing happens when the federal government lowers its tax rate. Without making any changes itself, the local government sees much more revenue. When both the federal and local governments employ 10% rates, collections total $500 each and economic activity is $5000. But again, the local government spends the $500 it raised which kicks off another tax flow. The process repeats with the governments each earning $250, then $125, then $63, etc.

Tax Flow Diagram 10% Federal 10% Local

In total the local government earns $1000, the same as the federal government, four times as much as when the federal tax rate was 40%. Local governments will be able to not only balance their budgets, but they will be able to lower their tax rate too.

40% Federal Tax and 10% Imports

So far we have seen that the federal government collects every dollar it spends, which is the definition of a balanced budget. But the reality is there is often a budget deficit where the revenue from taxing the citizens doesn't equal the spending outlays. The culprit is the trade imbalance with foreign countries. When we purchase more imports than other countries buy our exports, the money spent leaves the economy so it does not participate in the Tax Flow Diagram or the Currency Availability Multiplier.

Consider the economy where the federal government taxes at 40% and 10% of citizens' spending is on imported goods. The first person in the Tax Flow Diagram earns $1000, pays $400 in taxes, spends $500 on domestic goods, and buys $100 worth of imports. The $100 of imports is gone, it's not taxable by the federal government. The next person earns $500, spends $200 on taxes and $50 on imports. The process repeats with more money leaving the economy due to the trade imbalance. Total spending on imports is $200, total economic activity is $2200, and total federal government taxation is $800.

Tax Flow Diagram 40% Federal 10% Imports

In this example, there is a $200 deficit; the government spent $1000 but only received $800 in tax revenue. Politicians and economists declare that the budget is not balanced and look for ways to borrow the missing $200. The right way to treat the missing $200 is to simply put it in a new column of your budget spreadsheet for funds which have escaped the US economy. In this way the budget is always balanced, the federal government just spends what it's going to spend and receives revenue from taxing the citizenry according to the Tax Flow Diagram and Currency Availability Multiplier (CAM).

A deficit should not be looked at as undesirable. It's a sign that foreign countries want our dollars and are willing to supply us with products that are cheaper for them to make versus being made in the US. This situation has come about because our economy has some inflation every year, leading to rising prices. The same level of inflation is not seen in foreign countries so they are able to undercut US manufacturers, leading to more imported goods. If we can put a stop to inflation here in the US, eventually the value of the dollar in foreign countries will rise to match our own valuation and the budget deficit will shrink.

No Federal Tax and 10% Imports

Now for an unexpected result, let's look at what happens when there is a federal budget deficit and no federal taxes at all. As before, the first person in the Tax Flow Diagram collects $1000 in salary and spends it all, without taxes, with $100 going toward the purchase of imports. The next person earns the $900 left over and spends $90 on imports and $810 on domestic goods. Total economic activity is $11,000, spending on imports is $1000, and no money was spent on taxes.

Tax Flow Diagram 10% Imports

Forbes Tax Misery Index

Forbes Magazine published in 2008 an economic tool called the Tax Misery Index. They looked at the various taxes each country levied on their population and added the rates together to come up with a misery score.

Original Misery Scores

For example, in 2008, France had a corporate tax rate of 34.4%, personal income tax rate of 51%, employer social security tax of 45%, employee social security tax of 15%, and a Value Added Tax (VAT) of 19.6%. Adding up all of the percentages gives France a Misery Score of 165, the worst among the countries surveyed.

Forbes Tax Misery Scores 2008
Country Corporate
Income
Personal
Income
Employer
SS
Employee
SS
Sales Tax /
VAT
Tax Misery
Score
France 34.4% 51% 45% 15% 19.6% 165
Netherlands 25.5% 52% 17.6% 41.9% 20% 157
Belgium 34% 53.5% 34.8% 13.1% 21% 156
Sweden 28% 61% 32.4% 7% 25% 153
China 25% 45% 44.5% 20.5% 17% 152
Austria 25% 50% 31.5% 18% 20% 145
Italy 32.4% 45.2% 35% 10.2% 20% 143
Argentina 35% 35% 27% 17% 21% 135
Finland 26% 52.5% 27% 7.4% 22% 135
Hungary 20% 40% 32% 17% 20% 129
Greece 25% 40% 28.1% 16% 19% 128
Spain 30% 43% 30.2% 6.4% 16% 126
Brazil 34% 27.5% 28.8% 11% 25% 126
Portugal 26.5% 42% 23.8% 11% 21% 124
Poland 19% 40% 20% 23% 22% 124
Japan 41% 50% 13.6% 12.8% 5% 122
Slovenia 22% 41% 16.1% 22.1% 20% 121
Denmark 25% 59% 1% 8% 25% 118
Norway 28% 40% 14.1% 7.8% 25% 115
Switzerland 32.3% 40.8% 17.1% 16.1% 7.6% 114
Ukraine 25% 15% 50% 3.5% 20% 114
Turkey 20% 35% 22% 15% 18% 110
Mexico 28% 28% 35.7% 2.8% 15% 110
United Kingdom 28% 40% 12.8% 11% 17.5% 109
Luxembourg 29.6% 39% 11.4% 12.2% 15% 107
Canada 33.5% 46.4% 7.4% 6.7% 13% 107
Germany 15.8% 47.5% 12% 12% 19% 106
Slovakia 19% 19% 35.2% 13.4% 19% 106
Israel 26% 46% 5.4% 12% 15.5% 105
Romania 16% 16% 37.6% 15.5% 19% 104
Czech Republic 21% 12.5% 35% 12.5% 19% 100
Azerbaijan 22% 35% 22% 3% 18% 100
South Korea 27.5% 38.5% 14% 7.2% 10% 97
Australia 30% 45% 7% 2.8% 10% 95
Estonia 20% 20% 33.3% 2.6% 18% 94
Vietnam 25% 35% 17% 6% 10% 93
Uzbekistan 21.5% 25% 24% 2.5% 20% 93
Ireland 12.5% 41% 10.8% 6% 21% 91
Latvia 15% 25% 24.1% 9% 18% 91
Lithuania 15% 24% 31% 3% 18% 91
New Zealand 30% 39% 7.5% 1.3% 12.5% 90
India 42% 34% 12.5% 89
Indonesia 30% 35% 12% 2% 10% 89
Malaysia 25% 28% 12% 11% 10% 86
USA 35% 35% 7.7% 7.7% 85
Phillipines 30% 32% 7% 3.3% 12% 84
South Africa 28% 40% 1% 1% 14% 84
Russia 24% 13% 26% 18% 81
Taiwan 25% 40% 7.3% 2.7% 5% 80
Singapore 18% 20% 14.5% 20% 7% 80
Thailand 25% 37% 5% 5% 7% 79
Kazakhstan 30% 10% 27% 12% 79
Pakistan 35% 20% 7% 15% 77
Bulgaria 10% 10% 20.5% 13% 20% 74
Cyprus 10% 30% 10% 6.3% 15% 71
Macedonia 10% 10% 32.9% 18% 71
Malta 25% 10% 10% 18% 63
Georgia 15% 25% 18% 58
Hong Kong 16.5% 15% 5% 5% 42
UAE 13% 5% 18
Qatar 12% 12

Obviously a government can't take more than 100% in taxes so there must be a better way to interpret the data. I propose that we look at how much is left over after each tax is levied, and determine the equivalent of a single tax. The CAM multiplier is easily found once you have reduced the data to a single tax, it is just the reciprocal of the effective tax rate.

In the case of France, the corporate income tax is 34.4%, so 65.6% of income is retained. Personal income tax is 51% so 49% remains. Forty−five percent disappears due to employer social security so 55% is kept. Employee social security takes 15%, leaving the person with 85% of earnings, and finally 19.6% VAT leaves 80.4%. The effective tax rate is found by multiplying all of the retained funds together:

RetainedFundRate  =  0.656 × 0.49 × 0.55 × 0.85 × 0.804
RetainedFundRate  =  12%
EffectiveTaxRate  =  1 − RetainedFundRate
EffectiveTaxRate  =  88%
CAM  =  1 ÷ 0.88
CAM  =  1.136

Enhanced Misery Scores

Here are the Enhanced Tax Misery scores of the countries highlighted in the 2008 report. When you look at the CAM multiplier you can see why the economies of the world are struggling. The multipliers are so low there is not enough currency available to make a thriving economy. The solution is to get rid of all taxes except for one, and to adjust the tax rate to achieve the appropriate CAM multiplier. The highest multiplier in practice in 2008 was achieved by Qatar's sole 12% corporate income tax.

Countries' CAM Multipliers (2008)
Country Corporate
Income
Personal
Income
Employer
SS
Employee
SS
Sales Tax /
VAT
Effective
Tax
CAM
Multiplier
France 34.4% 51% 45% 15% 19.6% 87.9% 1.137
Netherlands 25.5% 52% 17.6% 41.9% 20% 86.3% 1.159
Belgium 34% 53.5% 34.8% 13.1% 21% 86.3% 1.159
Sweden 28% 61% 32.4% 7% 25% 86.8% 1.153
China 25% 45% 44.5% 20.5% 17% 84.9% 1.178
Austria 25% 50% 31.5% 18% 20% 83.1% 1.203
Italy 32.4% 45.2% 35% 10.2% 20% 82.7% 1.209
Argentina 35% 35% 27% 17% 21% 79.8% 1.254
Finland 26% 52.5% 27% 7.4% 22% 81.5% 1.227
Hungary 20% 40% 32% 17% 20% 78.3% 1.277
Greece 25% 40% 28.1% 16% 19% 78.0% 1.282
Spain 30% 43% 30.2% 6.4% 16% 78.1% 1.280
Brazil 34% 27.5% 28.8% 11% 25% 77.3% 1.294
Portugal 26.5% 42% 23.8% 11% 21% 77.2% 1.296
Poland 19% 40% 20% 23% 22% 76.6% 1.305
Japan 41% 50% 13.6% 12.8% 5% 78.9% 1.268
Slovenia 22% 41% 16.1% 22.1% 20% 75.9% 1.317
Denmark 25% 59% 1% 8% 25% 79.0% 1.266
Norway 28% 40% 14.1% 7.8% 25% 74.3% 1.345
Switzerland 32.3% 40.8% 17.1% 16.1% 7.6% 74.2% 1.347
Ukraine 25% 15% 50% 3.5% 20% 75.4% 1.326
Turkey 20% 35% 22% 15% 18% 71.7% 1.394
Mexico 28% 28% 35.7% 2.8% 15% 72.5% 1.380
United Kingdom 28% 40% 12.8% 11% 17.5% 72.3% 1.382
Luxembourg 29.6% 39% 11.4% 12.2% 15% 71.6% 1.397
Canada 33.5% 46.4% 7.4% 6.7% 13% 73.2% 1.366
Germany 15.8% 47.5% 12% 12% 19% 72.3% 1.384
Slovakia 19% 19% 35.2% 13.4% 19% 70.2% 1.425
Israel 26% 46% 5.4% 12% 15.5% 71.9% 1.391
Romania 16% 16% 37.6% 15.5% 19% 69.9% 1.431
Czech Republic 21% 12.5% 35% 12.5% 19% 68.2% 1.467
Azerbaijan 22% 35% 22% 3% 18% 68.5% 1.459
South Korea 27.5% 38.5% 14% 7.2% 10% 68.0% 1.471
Australia 30% 45% 7% 2.8% 10% 68.7% 1.456
Estonia 20% 20% 33.3% 2.6% 18% 65.9% 1.517
Vietnam 25% 35% 17% 6% 10% 65.8% 1.520
Uzbekistan 21.5% 25% 24% 2.5% 20% 65.1% 1.536
Ireland 12.5% 41% 10.8% 6% 21% 65.8% 1.520
Latvia 15% 25% 24.1% 9% 18% 63.9% 1.565
Lithuania 15% 24% 31% 3% 18% 64.5% 1.549
New Zealand 30% 39% 7.5% 1.3% 12.5% 65.9% 1.518
India 42% 34% 12.5% 66.5% 1.504
Indonesia 30% 35% 12% 2% 10% 64.7% 1.546
Malaysia 25% 28% 12% 11% 10% 61.9% 1.615
USA 35% 35% 7.7% 7.7% 64.0% 1.562
Phillipines 30% 32% 7% 3.3% 12% 62.3% 1.604
South Africa 28% 40% 1% 1% 14% 63.6% 1.573
Russia 24% 13% 26% 18% 59.9% 1.670
Taiwan 25% 40% 7.3% 2.7% 5% 61.4% 1.628
Singapore 18% 20% 14.5% 20% 7% 58.3% 1.716
Thailand 25% 37% 5% 5% 7% 60.3% 1.657
Kazakhstan 30% 10% 27% 12% 59.5% 1.680
Pakistan 35% 20% 7% 15% 58.9% 1.698
Bulgaria 10% 10% 20.5% 13% 20% 55.2% 1.812
Cyprus 10% 30% 10% 6.3% 15% 54.8% 1.823
Macedonia 10% 10% 32.9% 18% 55.4% 1.804
Malta 25% 10% 10% 18% 50.2% 1.993
Georgia 15% 25% 18% 47.7% 2.095
Hong Kong 16.5% 15% 5% 5% 35.9% 2.782
UAE 13% 5% 17.3% 5.764
Qatar 12% 12.0% 8.333

Choosing the Best Tax

We have seen from the Tax Flow Diagrams that we only need one tax to create a prospering economy, and the tax rate is chosen to provide a large enough CAM multiplier so that there is enough currency available to facilitate all of the transactions people want to make. Federal taxation is not about raising revenue to fund the government, the purpose is to slowly pull currency out of the economy to limit the economic activity to an appropriate size.

The Tax Flow Diagrams above all utilize an Income Tax with a single tax rate, but let's investigate whether there is a better tax to choose for creating a robust economy.

List of Available Taxes

The arsenal of taxes available in the US are:

One tax that the US does not currently have is a federal Sales Tax, and it turns out that this is the best single tax to create a functioning economy.

Tax Attributes

The criteria for selecting a tax to be used in creating a robust economy include:

Adequacy
The chosen tax needs to be able to create an economy of a particular size given the tax rate and amount of government spending
Simplicity
The chosen tax must be easy to describe and understand
Fairness
The chosen tax must be equitable, not favoring any particular group
Efficiency
The chosen tax must be easy to collect and ensure that people are complying with its collection
Stability
The chosen tax must provide a predictable stream of tax revenue so the total economic activity doesn't vary much from year to year (no inflation)
Flexibility
The chosen tax must be adaptable to changing economic conditions, especially as the economy grows larger

Tax Comparison

Let's look at how each of the taxes fares when trying to create a robust economy:

Tax Adeq Simp Fair  Eff  Stab Flex
Personal Income Tax X X X
Corporate Income Tax X X X X X X
Payroll Taxes X X
Tax on Capital Gains X X X X X X
Tax on Interest X X X X X
Estate Tax X X X X X X
Gift Tax X X X X X X
Excise Taxes X X X X X X
Sales Tax

Sales Tax

The only tax which checks all of the boxes is a federal Sales Tax. It's simple − all retail purchases have a tax added just like the state or local sales tax. It's extremely efficient since there is virtually no paperwork needed − people and businesses don't need to keep receipts or submit tax returns. One hundred percent of income earned is kept by workers which they can choose to invest or spend as their needs dictate. One hundred percent of capital gains and interest earned are kept by investors. One hundred percent of your assets go to your heirs when you die. Gifts of cash or property can be freely given to whomever you want with no limit and no payments to the government. The hundreds of billions of dollars spent annually on complying with the tax code and the billions of hours wasted can be put to better use.

The only records which need to be kept are sales taxes collected by retail businesses, which are remitted to the federal government. They already do this for local governments so the added burden will be minimal. The IRS or Federal Reserve can be repurposed to collect the sales tax and to monitor the economy to determine the sales tax rate and to adjust it as needed. As the economy grows, the sales tax rate must be decreased to increase the CAM multiplier.

The tax rate in the Tax Flow Diagrams assumes that the tax is an income tax with tax taken out of your paycheck. The sales tax is different; it's added onto purchases as funds are spent in the economy. There's a simple conversion for determining the equivalent sales tax rate:

SalesTaxRate = IncomeTaxRate ÷ (1 − IncomeTaxRate)

For example, if the income tax rate is 50% and $1000 is earned, $500 is spent and $500 goes to the government. Looking at the same example as a sales tax, 100% of the $500 spent is sent to the government.

The lower the income tax rate, the closer is the sales tax rate:

Income Tax Rate     Sales Tax Rate
60% 150%
50% 100%
40% 67%
30% 43%
20% 25%
10% 11%
5% 5.3%

Now let's look at all the other taxes to see why they're inferior to the Sales Tax.

Personal Income Tax

We see from the Tax Flow Diagrams that an economy can function with a personal income tax with a single tax rate levied on everyone equally. The current income tax in the US is much more complicated, requiring thousands of pages of documentation to describe all of the intricacies. In its current incarnation, the personal income tax is not suitable due to the progressive tax brackets where higher income earners pay a higher percentage of their earnings. This is due to the erroneous thinking that federal taxation is meant to raise revenue to fund government activity.

A much simpler income tax with a single tax rate would be adequate to create a thriving economy, but it still requires payments to the government by each individual worker. These payments would likely be collected by their employers similar to how taxes are withheld today. A bigger problem with the personal income tax is the fact that it is taken out of a person's income before they have made any purchases or investments. A better way to collect taxes is as a sales tax which is directly linked to economic activity, and which is a much more efficient way to collect the tax.

Corporate Income Tax

Corporations are taxed based on their profits, not on products sold, so there is not a direct link between economic activity and taxes raised from businesses. Far from simple, much of the thousands of pages of the tax code deal with corporate taxes, and businesses waste a lot of time and money making decisions based on how their taxes will be impacted, rather than on the desirability of the decision.

Payroll Taxes

Payroll Taxes are collected from employers and employees to fund the Social Security & Medicare programs. They are similar to a flat income tax, though there is a cap to the Social Security tax. With the cap lifted, the Payroll Taxes could be used to create a thriving economy by setting the tax rate according to the CAM multiplier of the Tax Flow Diagram.

However, the Payroll Tax is collected only from wage earners; people who derive their income from investments don't pay the Payroll Tax, so it is inherently unfair to the poor and Middle Class. Also the efficiency of collecting the Payroll Taxes is no match for the simplicity and ease of collecting a Sales Tax.

Tax on Capital Gains and Interest

Taxes on Capital Gains and Interest are relics of the erroneous thinking that taxes are meant to raise revenue for the federal government. Up to a third or more of profits from the sale of assets which have appreciated in value, or interest earned in a bank account, for example, is relinquished to the government. These taxes are devastating to investors who are trying to build an investment portfolio to fund their lifestyle and retirement.

For example, if you were to purchase a stock for $100 per share and the value increased over some time period to $200 per share, you would have to pay tax on the $100 gain. If the Capital Gains Tax rate was 35%, you would only receive $165 for your shares, much less than the value of the commodities. Or if you are unfortunately selling an asset which has gone down in value, the government doesn't offer a rebate on the loss.

Record keeping is onerous as well for the Capital Gains Tax since the tax is applied to the gains made over and above the purchase price. If you continually invest in stocks over many years, a list of the purchase price of each individual share must be kept in order to properly calculate the gains associated with the sale.

Tax on interest earned is even more insidious since it affects the performance of the investment. The "Rule of 72" is an approximation for how long it takes an interest−bearing investment to double in value at a given interest rate. For example, a loan which earns 6% annually will double in value in about 72 ÷ 6 = 12 years. However, when the federal government collects a third of the interest earned each year, you are actually only receiving a return of 4%, so by the Rule of 72, your investment takes 72 ÷ 4 = 18 years to double in value. Over many decades, this reduction in performance is a disaster.

Estate Tax (Death Tax)

At the end of your life, the federal government takes a hefty portion of your estate in an attempt to raise revenue. As has been said many times, the purpose of federal taxation is to create an economy of the appropriate size for the population, not to raise revenue for government operations, so taking assets from the estates of deceased persons is an antiquated concept. As much as 40% or more of a large estate can be demanded by the government, which is disastrous to the surviving heirs.

Since the estate will consist of appreciated assets, and maybe even a family business, there is not a pile of cash from which the 40% share can be gotten. To comply with the demand for 40% of the cash value of the estate, many of the estate's assets will need to be sold. In the case of a family business, it may not be possible to sell half of the business and still be a viable operation, destroying the legacy of the decedent. Also as mentioned, the Capital Gains Tax will apply to the sale of the appreciated assets, so more than 40% of the entire estate will need to be sold in order to net 40%.

Gift Tax

The Gift Tax exists because the government wants to prevent you from giving your assets away before you die and not paying the Estate Tax. You are allowed to give a small amount of money away each year with no tax penalty, but this amount is barely above the poverty line. Giving money away to people in need should be encouraged since the recipients may need to rely less upon social welfare programs. Since the Estate Tax and Gift Tax were designed to raise money to fund the government, which we've learned is the wrong way to think about federal taxes, they are no longer needed.

Excise Taxes

Excise taxes are on specific products like gasoline, cigarettes and alcohol. These taxes are meant to raise revenue for the federal government in addition to attempting to influence behavior (i.e. they are trying to deter smoking and curb drinking alcoholic beverages). Since the purpose of taxation is to create an economy of a specific size, the one tax needs to cover all transactions, not just a small collection of products. Attempts to influence behavior by applying taxes to controversial products is unjust.

Value Added Tax (VAT)

The US fortunately does not have a Value Added Tax as many other countries do. It's a complex scheme where businesses pay a tax on the amount of value they add to an item as it gets closer to sale. It's often conflated with being a form of sales tax, but it's not nearly as efficient since it requires a lot of bookkeeping.

Determining the Tax Rate

The Laffer Curve

One of the more successful economic theories is the Laffer Curve championed by economist Arthur Laffer. It attempts to find the optimal tax rate for the government to maximize its revenue.

It is simple to explain. If the federal government had a tax rate of zero percent, they would collect no revenue from economic activity. If instead the government taxed at 100 percent, taking all of your earnings, there would be no incentive to work so they would also get no revenue. A graph showing the tax rate on the horizontal axis and tax revenue on the vertical axis must start at zero revenue at a zero percent tax rate, rise to a maximum somewhere between zero and 100 percent tax rate, and then fall back down to zero revenue at 100 percent tax rate. The peak in the curve is at t*, the optimal tax rate for maximizing government revenue.

Laffer Curve

If the current tax rate is to the left of t*, then an increase in the tax rate will result in more government revenue, or if the current tax rate is to the right of t*, then a reduction in the tax rate will result in more revenue.

Occasionally economists on the news will ponder whether we're currently taxing more or less than the optimal rate, t* of the Laffer Curve and offering their opinion on what to do.

Laffer Curve Flaw

Unfortunately the Laffer Curve is defective and does not offer any insight into setting the tax rate. The problem, aside from the bigger question of why economists think the optimal government tax rate is where they harvest the most revenue from taxpayers, is that the horizontal axis is supposed to have only one varying parameter, the tax rate. But the Laffer Curve has full employment at a tax rate of zero percent, and a hundred percent unemployment at a tax rate of 100%. If the level of employment remained the same at each tax rate, the government would certainly raise a lot of revenue as the tax rate climbed.

Modified Laffer Curve

We saw in the Tax Flow Diagrams above that the federal government can only collect in taxes the amount it spends in the economy (if people are not forced into spending their savings or borrowing on their credit cards). Government revenue is the same at every tax rate, the variable is the CAM (Currency Availability Multiplier) which determines the size of the economy. A more accurate version of the Laffer Curve follows:

Modified Laffer Curve

The optimal tax rate, t*, is the reciprocal of the CAM multiplier, which is the Total Economic Activity (TEA, also known as the Gross Domestic Product or GDP) divided by government revenue.

t*  =  1 ÷ CAM
   =  GovernmentRevenue ÷ TEA

Varying the tax rate changes the CAM multiplier. If the tax rate is increased above t*, the CAM goes down and the economy shrinks, resulting in less economic activity. The economy supports fewer transactions at a higher tax rate, forcing people to do with less, or to spend some of their savings or even to go into debt.

Reducing the tax rate below t* increases the CAM and leads to higher TEA/GDP. If the increase in CAM is small, the economy can absorb the added economic activity without leading to inflation. Too much and there aren't enough surplus goods to keep the size of the economy in check.

History of US Taxation

The US did not always have an income tax. Passage of the Sixteenth Amendment to the Constitution in 1913 marked the time when the personal income tax became a permanent US tax. The initial tax brackets were single digit percentages from 1% for the lowest earners up to 7% for the wealthy. We'll see that these tax rates are already too high, but this fact did not prevent politicians from raising them ever higher.

The following table examines the history of taxation in the US from 1901 to present (2023). For each year, we have federal government revenue, federal government spending, the surplus or deficit for the year, and the TEA/GDP which resulted. From these data we determine the range of values of the CAM multiplier which would be necessary to attain an appropriately sized economy.

The CAM can be as low as the GDP divided by the larger of federal revenue and federal spending, or as high as the GDP divided by the smaller of federal revenue and federal spending. We saw in the Tax Flow Diagrams that the federal tax rate needs to be set to the inverse of the CAM to achieve enough economic activity. The next two columns show the range of tax rates which correspond to the range of CAM multipliers. The low end of the federal tax rate range is the inverse of the high value of the CAM, and the high end of the federal tax rate range is the inverse of the low value of the CAM.

The final two columns show the tax rates for the lowest income tax bracket and the highest income tax bracket in effect in the US that year.

US Taxation 1901 to Present

[[ Blue highlights in the table correspond to the two World Wars ]]

 Year  Revenue
(Billions)
Spending
(Billions)
Surplus
(Billions)
TEA/GDP
(Billions)
 CAM 
Low
 CAM 
High
Tax Rate
Low
Tax Rate
High
Income
Tax Low
Income
Tax High
1901 0.588 0.525 0.063 22.4 38.1 42.7 2.3 2.6
1902 0.562 0.485 0.077 24.2 43.1 49.9 2.0 2.3
1903 0.562 0.517 0.045 26.1 46.4 50.5 2.0 2.2
1904 0.541 0.584 −0.043 25.8 44.2 47.7 2.1 2.3
1905 0.544 0.567 −0.023 28.9 51.0 53.1 1.9 2.0
1906 0.595 0.570 0.025 30.9 51.9 54.2 1.8 1.9
1907 0.666 0.579 0.087 34.0 51.1 58.7 1.7 2.0
1908 0.602 0.659 −0.057 30.3 46.0 50.3 2.0 2.2
1909 0.604 0.694 −0.089 32.2 46.4 53.3 1.9 2.2
1910 0.676 0.694 −0.018 33.4 48.1 49.4 2.0 2.1
1911 0.702 0.691 0.011 34.3 48.9 49.6 2.0 2.0
1912 0.693 0.690 0.003 37.4 54.0 54.2 1.8 1.9
1913 0.714 0.715 −0.001 39.1 54.7 54.8 1.8 1.8 1 7
1914 0.725 0.726 −0.001 36.5 50.3 50.3 2.0 2.0 1 7
1915 0.683 0.746 −0.063 38.7 51.9 56.7 1.8 1.9 1 7
1916 0.761 0.713 0.048 49.6 65.2 69.6 1.4 1.5 2 15
1917 1.101 1.954 −0.853 59.7 30.6 54.2 1.8 3.3 2 67
1918 3.645 12.677 −9.032 75.8 6.0 20.8 4.8 16.7 6 77
1919 5.130 18.493 −13.363 78.3 4.2 15.3 6.6 23.6 4 73
1920 6.649 6.358 0.291 88.4 13.3 13.9 7.2 7.5 4 73
1921 5.571 5.062 0.509 73.6 13.2 14.5 6.9 7.6 4 73
1922 4.026 3.289 0.736 73.4 18.2 22.3 4.5 5.5 4 58
1923 3.853 3.140 0.713 85.4 22.2 27.2 3.7 4.5 3 43.5
1924 3.871 2.908 0.963 87.0 22.5 29.9 3.3 4.4 1.5 46
1925 3.641 2.924 0.717 90.6 24.9 31.0 3.2 4.0 1.125 25
1926 3.795 2.930 0.865 97.0 25.6 33.1 3.0 3.9 1.125 25
1927 4.013 2.857 1.155 95.5 23.8 33.4 3.0 4.2 1.125 25
1928 3.900 2.961 0.939 97.4 25.0 32.9 3.0 4.0 1.125 25
1929 3.862 3.127 0.734 103.6 26.8 33.1 3.0 3.7 0.375 24
1930 4.058 3.320 0.738 91.2 22.5 27.5 3.6 4.4 1.125 25
1931 3.116 3.577 −0.462 76.5 21.4 24.6 4.1 4.7 1.125 25
1932 1.924 4.659 −2.735 58.7 12.6 30.5 3.3 7.9 4 63
1933 1.997 4.598 −2.602 56.4 12.3 28.2 3.5 8.2 4 63
1934 2.955 6.541 −3.586 66.0 10.1 22.3 4.5 9.9 4 63
1935 3.609 6.412 −2.803 73.3 11.4 20.3 4.9 8.7 4 63
1936 3.923 8.228 −4.304 83.8 10.2 21.4 4.7 9.8 4 79
1937 5.387 7.580 −2.193 91.9 12.1 17.1 5.9 8.2 4 79
1938 6.751 6.840 −0.089 86.1 12.6 12.8 7.8 7.9 4 79
1939 6.295 9.141 −2.846 92.2 10.1 14.6 6.8 9.9 4 79
1940 6.548 9.468 −2.920 98.2 10.4 15.0 6.7 9.6 4.4 81.1
1941 8.712 13.653 −4.941 116.2 8.5 13.3 7.5 11.7 10 81
1942 14.634 35.137 −20.503 147.7 4.2 10.1 9.9 23.8 19 88
1943 24.001 78.555 −54.554 184.6 2.3 7.7 13.0 42.6 19 88
1944 43.747 91.304 −47.557 213.8 2.3 4.9 20.5 42.7 23 94
1945 45.159 92.712 −47.553 226.4 2.4 5.0 19.9 41.0 23 94
1946 39.296 55.232 −15.936 228.0 4.1 5.8 17.2 24.2 19 86.45
1947 38.514 34.496 4.018 238.9 6.2 6.9 14.4 16.1 19 86.45
1948 41.560 29.764 11.796 261.9 6.3 8.8 11.4 15.9 16.6 82.13
1949 39.415 38.835 0.580 276.5 7.0 7.1 14.0 14.3 16.6 82.13
1950 39.443 42.562 −3.119 278.7 6.5 7.1 14.2 15.3 17.4 84.36
1951 51.616 45.514 6.102 327.1 6.3 7.2 13.9 15.8 20.4 91
1952 66.167 67.686 −1.519 357.1 5.3 5.4 18.5 19.0 22.2 92
1953 69.608 76.101 −6.493 382.1 5.0 5.5 18.2 19.9 22.2 92
1954 69.701 70.855 −1.154 387.2 5.5 5.6 18.0 18.3 20 91
1955 65.451 68.444 −2.993 406.3 5.9 6.2 16.1 16.8 20 91
1956 74.587 70.640 3.947 438.3 5.9 6.2 16.1 17.0 20 91
1957 79.990 76.578 3.412 463.4 5.8 6.1 16.5 17.3 20 91
1958 79.636 82.405 −2.769 473.5 5.7 5.9 16.8 17.4 20 91
1959 79.249 92.098 −12.849 504.6 5.5 6.4 15.7 18.3 20 91
1960 92.492 92.191 0.301 534.3 5.8 5.8 17.3 17.3 20 91
1961 94.388 97.723 −3.335 546.6 5.6 5.8 17.3 17.9 20 91
1962 99.676 106.821 −7.146 585.7 5.5 5.9 17.0 18.2 20 91
1963 106.560 111.316 −4.756 618.2 5.6 5.8 17.2 18.0 20 91
1964 112.613 118.528 −5.915 661.7 5.6 5.9 17.0 17.9 16 77
1965 116.817 118.228 −1.411 709.3 6.0 6.1 16.5 16.7 14 70
1966 130.835 134.532 −3.698 780.5 5.8 6.0 16.8 17.2 14 70
1967 148.822 157.464 −8.643 836.5 5.3 5.6 17.8 18.8 14 70
1968 152.973 178.134 −25.161 897.6 5.0 5.9 17.0 19.8 14 75.25
1969 186.882 183.640 3.242 980.3 5.2 5.3 18.7 19.1 14 77
1970 192.807 195.649 −2.842 1046.7 5.3 5.4 18.4 18.7 14 71.75
1971 187.139 210.172 −23.033 1116.6 5.3 6.0 16.8 18.8 14 70
1972 207.309 230.681 −23.373 1216.3 5.3 5.9 17.0 19.0 14 70
1973 230.799 245.707 −14.908 1352.7 5.5 5.9 17.1 18.2 14 70
1974 263.224 269.359 −6.135 1482.9 5.5 5.6 17.8 18.2 14 70
1975 279.090 332.332 −53.242 1606.9 4.8 5.8 17.4 20.7 14 70
1976 298.060 371.792 −73.732 1786.1 4.8 6.0 16.7 20.8 14 70
1977 355.559 409.218 −53.659 2024.3 4.9 5.7 17.6 20.2 14 70
1978 399.561 458.746 −59.185 2273.5 5.0 5.7 17.6 20.2 14 70
1979 463.302 504.028 −40.726 2565.6 5.1 5.5 18.1 19.6 14 70
1980 517.112 590.941 −73.830 2791.9 4.7 5.4 18.5 21.2 14 70
1981 599.272 678.241 −78.968 3133.2 4.6 5.2 19.1 21.6 13.825 69.125
1982 617.766 745.743 −127.977 3313.4 4.4 5.4 18.6 22.5 12 50
1983 600.562 808.364 −207.802 3536.0 4.4 5.9 17.0 22.9 11 50
1984 666.438 851.805 −185.367 3949.2 4.6 5.9 16.9 21.6 11 50
1985 734.037 946.344 −212.308 4265.1 4.5 5.8 17.2 22.2 11 50
1986 769.155 990.382 −221.227 4526.3 4.6 5.9 17.0 21.9 11 50
1987 854.287 1004.017 −149.730 4767.7 4.7 5.6 17.9 21.1 11 38.5
1988 909.238 1064.416 −155.178 5138.6 4.8 5.7 17.7 20.7 15 28
1989 991.104 1143.743 −152.639 5554.7 4.9 5.6 17.8 20.6 15 28
1990 1031.958 1252.993 −221.036 5898.8 4.7 5.7 17.5 21.2 15 28
1991 1054.988 1324.226 −269.238 6093.2 4.6 5.8 17.3 21.7 15 31
1992 1091.208 1381.529 −290.321 6416.3 4.6 5.9 17.0 21.5 15 31
1993 1154.334 1409.386 −255.051 6775.3 4.8 5.9 17.0 20.8 15 39.6
1994 1258.566 1461.752 −203.186 7176.9 4.9 5.7 17.5 20.4 15 39.6
1995 1351.790 1515.742 −163.952 7560.4 5.0 5.6 17.9 20.0 15 39.6
1996 1453.053 1560.484 −107.431 7951.3 5.1 5.5 18.3 19.6 15 39.6
1997 1579.232 1601.116 −21.884 8451.0 5.3 5.4 18.7 18.9 15 39.6
1998 1721.728 1652.458 69.270 8930.8 5.2 5.4 18.5 19.3 15 39.6
1999 1827.452 1701.842 125.610 9497.6 5.2 5.6 17.9 19.2 15 39.6
2000 2025.191 1788.950 236.241 10117.1 5.0 5.7 17.7 20.0 15 39.6
2001 1991.082 1862.846 128.236 10525.7 5.3 5.7 17.7 18.9 10 39.1
2002 1853.136 2010.894 −157.758 10828.9 5.4 5.8 17.1 18.6 10 38.6
2003 1782.314 2159.899 −377.585 11278.8 5.2 6.3 15.8 19.2 10 35
2004 1880.114 2292.841 −412.727 12028.4 5.2 6.4 15.6 19.1 10 35
2005 2153.611 2471.957 −318.346 12840.0 5.2 6.0 16.8 19.3 10 35
2006 2406.869 2655.050 −248.181 13636.8 5.1 5.7 17.6 19.5 10 35
2007 2567.985 2728.686 −160.701 14305.4 5.2 5.6 18.0 19.1 10 35
2008 2523.991 2982.544 −458.553 14796.6 5.0 5.9 17.1 20.2 10 35
2009 2104.989 3517.677 −1412.688 14467.3 4.1 6.9 14.5 24.3 10 35
2010 2162.706 3457.079 −1294.373 14884.4 4.3 6.9 14.5 23.2 10 35
2011 2303.466 3603.065 −1299.599 15466.5 4.3 6.7 14.9 23.3 10 35
2012 2449.990 3526.563 −1076.573 16109.4 4.6 6.6 15.2 21.9 10 35
2013 2775.106 3454.881 −679.775 16665.1 4.8 6.0 16.7 20.7 10 39.6
2014 3021.491 3506.284 −484.793 17370.8 5.0 5.7 17.4 20.2 10 39.6
2015 3249.890 3691.850 −441.960 18086.1 4.9 5.6 18.0 20.4 10 39.6
2016 3267.965 3852.615 −584.650 18536.1 4.8 5.7 17.6 20.8 10 39.6
2017 3316.184 3981.634 −665.450 19245.7 4.8 5.8 17.2 20.7 10 39.6
2018 3329.907 4109.047 −779.140 20302.0 4.9 6.1 16.4 20.2 10 37
2019 3463.364 4446.960 −983.596 21159.2 4.8 6.1 16.4 21.0 10 37
2020 3421.164 6553.621 −3132.457 21060.9 3.2 6.2 16.2 31.1 10 37
2021 4047.111 6822.470 −2775.359 22654.0 3.3 5.6 17.9 30.1 10 37
2022 4897.399 6273.324 −1375.925 25000.4 4.0 5.1 19.6 25.1
2023 4802.483 6371.827 −1569.344 26335.7 4.1 5.5 18.2 24.2
1Receipts, Outlays, and Surpluses or Deficits 1789−2028 at govinfo.gov
2Source for revenue, spending, and surpluses/deficits at whitehouse.gov
3US GDP data 1790−2006 from Wikipedia
4Alternate US GDP data 1790 to present from measuringworth.com
5The American Presidency Project at UC Santa Barbara

In the years leading up to 1913, the US raised revenue mostly from tariffs on imported goods and excise taxes on a few specific products such as alcohol and tobacco. The CAM multiplier during those years was consistently around 50, which corresponds to an income tax rate of just 2%, or even less. The overall US economy in the first decade of the twentieth century was around fifty times larger than the federal government.

If the economists and politicians of the time had understood how taxation works according to the Tax Flow Diagram, they would have created a tax with a single tax bracket of just 2% for everyone and rescinded all other taxation and revenue raising efforts.

Instead, the politicians and economists continually tinkered with income tax rates, often collecting more than 70% of the income of the wealthiest Americans, and hitting a maximum of 94% (!!) tax rate during the second World War. For every $1000 earned, the wealthiest Americans would only get to keep a paltry $60. Even if you could justify this theft as wartime funding of the government, the highest tax rate remained between 82% and 92% for 18 years after the Second World War ended, followed by another 18 years between 70% and 77%.

It's not at all surprising that the affluent would try to hide their income from the government. Considering that a flat tax of just 2% would have generated a perfectly functioning economy, it's sad to think about how many businesses shuttered due to the deflationary pressure of such high taxes. Many of the businesses that did survive had to move their operations to foreign countries to escape the reach of the US government.

US Taxation Before 1913

Let's look at how the economy was functioning prior to 1913 before the income tax came into effect. In 1901, the US raised $588 million in tax revenue from an economy with a GDP of $22.4 billion. In 1912 the government raised $693 million from an economy of $37.4 billion.

588 × (1 + r)11  =  693
(1 + r)  =  11√ (693 ÷ 588)
r  =  1.5%

The federal government was growing at a rate of 1.5% per year. Let's look at how the economy grew over the same time period. In 1901 the GDP was $22.4 billion which grew to $37.4 billion by 1912.

22.4 × (1 + r)11  =  37.4
(1 + r)  =  11√(37.4 ÷ 22.4)
r  =  4.77%

The economy was growing at a rate three times faster than the rate at which the federal government was growing.

US Taxation After 1913

Once the income tax was introduced, along with the extreme tax rates that the Congress levied on the population, the trend of expansion turned around and deflated the economy. The US government collected $714 million in 1913 and 110 years later in 2023 raised $4.803 trillion.

0.714 × (1 + r)110  =  4803
(1 + r)  =  110√(4803 ÷ 0.714)
r  =  8.34%

The government grew at a rate of more than 8% per year on average. Meanwhile the GDP was also growing, starting out at $39.1 billion in 1913, and reaching $26.336 trillion in 2023, but the annualized growth rate was only about 6%:

39.1 × (1 + r)110  =  26336
(1 + r)  =  110√(26336 ÷ 39.1)
r  =  6.1%

110 Years of Deflation

Over the course of 110 years, the US government grew at an annual rate of 8.34% while the US economy expanded at a rate of just 6.1%. One hundred and ten years is a long time, and this two percent difference leads to an economy which is only one−tenth of what it could have been, with the federal government growing ten times larger:

((1 + 0.0834) ÷ (1 + 0.061))110  =  9.96
 Year  Revenue
(Billions)
Spending
(Billions)
Surplus
(Billions)
TEA/GDP
(Billions)
 CAM 
Low
 CAM 
High
Tax Rate
Low
Tax Rate
High
Income
Tax Low
Income
Tax High
2023 4802.483 6371.827 −1569.344 26335.7 4.1 5.5 18.2 24.2

In the most recent year (2023), the Federal government spent a bit more than $6.3 trillion dollars and collected about $4.8 trillion in revenue. The size of the resulting economy (TEA/GDP) was around $26 trillion. These numbers correspond to a CAM multiplier between 4.1 and 5.5, and the tax rate needed to support a thriving economy is somewhere between 18.2% and 24.2%.

If the GDP had kept pace with the growth of the government, the CAM multiplier would be 10 times as large and the federal tax rate would need to be just one−tenth of its current value, somewhere between 1.8% and 2.4%.

A Return to Sanity

But these numbers are a reflection of the economy after it has been gutted by 110 years of too−high tax rates, and massive amounts of new spending in the past few years. An easy first step would be to reduce federal spending back to pre−pandemic levels and reduce the tax rate to match. Five years ago in 2018, federal tax revenue was $3.3 trillion dollars and spending was $4.1 trillion. The current size of the economy in 2023 is $26.3 trillion dollars, so the CAM necessary to generate this economy is between 6.4 and 8.0.

The tax rate corresponding to this range of multipliers is between 12.5% and 15.6%. But creating a sales tax with this rate is just the first step, over time we want to undo the destruction to the economy and regain the factor−of−ten shrinkage. This requires slowly lowering the tax rate every year (or even every month) to boost the CAM multiplier and support a larger economy. It will take many years for all of the businesses that moved operations overseas to return, and for all of the new businesses that people want to start but can't afford to, to launch.

The Long Term Fix

Our goal is to fix the US economy, so somehow we need to establish a federal sales tax and set the initial tax rate to around 14%. But this is just the initial tax rate, the long term goal is to have the tax rate in the range of about 2%. Over the next several years, the federal tax rate needs to be systematically reduced until the CAM multiplier reaches into the range of about 50 times. It took over 100 years to reach where we are today, it will take many years to rectify the situation and wind up with a sales tax of around 2%.

Fourteen percent might sound like a lot of sales tax, but this is the replacement for all other Federal taxes. Even the poorest US citizens currently pay 15.3% of their entire salary to the government for payroll taxes (Social Security and Medicare), and at least 10% of their earnings above $22,500 for income tax, so they will be doing better immediately upon enacting the national sales tax.

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