Introduction
Mr. Chairman and Members of the Committee, it is a great privilege to testify at these hearings on fundamental tax reform. My name is Michael Rothschild. I am president of The Bionomics Institute, an educational foundation based in San Rafael, California. The mission of the Bionomics Institute is to help policy makers and the general public understand how the radical technological breakthroughs of our age are transforming the fundamental nature of economic life. Our work is supported by hundreds of private individuals, including many high-tech entrepreneurs, committed to helping bring about a new era of freedom, opportunity, and prosperity for all Americans.
We believe that recent breakthroughs in information technology have created an historically unprecedented opportunity for an explosive increase in human prosperity. Not all nations, however, will seize this moment and make the most of the stunning opportunities presented by the rise of the Information Age. Indeed, we believe that unless the United States quickly abandons obsolete economic policies -- like the federal income tax -- that were originally designed for the conditions of the Machine Age, the American people may miss their chance to achieve the great prosperity promised by the Information Age. Along with balancing the federal budget, we believe that replacing the federal income tax with a non-regressive National Sales Tax is the single most vital economic reform Congress can make in creating an environment that nurtures rapid and sustained economic growth.
Just as the fall of the Berlin Wall marked a new epoch in world affairs, last November's election (following the Wall's collapse five years to the day) opened a new era in American political life. Almost no one predicted it, but we are now living through a period of sudden, discontinuous change -- a radical transformation of human society. We are leaving the Machine Age and entering the Information Age.
Grasping the economic policy implications of this transformation must begin with an understanding of its root cause: a technological innovation of unprecedented magnitude. Consider this fact: Every week, without pause, one billion new microchips flow from factories around the world. A billion a week. By the year 2000, that number will be two billion a week. Just 25 years ago, the number was zero.
Microprocessors, DRAM memory, SRAM memory, ASIC chips, microcontrollers, electro-optical converters, and a menagerie of other specialized chips pour out of assembly facilities to be immediately stuffed into personal computers, cellphones, pagers, fax machines, satellites, CAT scanners, camcorders, cars, and an ever-expanding list of intelligent machines.
Services that we already take for granted -- paying by credit card at the gas pump or drawing cash from an automatic teller machine -- were inconceivable in 1969, when Neil Armstrong set foot upon the moon. The Internet. Desktop videoconferencing. Genetically engineered foods. Direct satellite broadcasting. The future is coming on so fast it seems like someone's jammed history's fast forward button. What was technically impossible yesterday is here now and it's cheap -- all because of the microchip.
Since the computer-on-a-chip was invented in 1971, the cost of handling information has plunged ten million-fold. That's like being able to buy a brand new $175 million Boeing 747 for the price of a large pizza. Never before in human history has the cost anything dropped so far so fast. And given what the semiconductor technologists already know how to do, we will witness another thousand-fold cost plunge in the next five years.
If the price of crude oil were projected to drop a thousand-fold -- from $20 to 2 cents a barrel, every economic forecaster would predict an enormous boom. Lower prices for gasoline, heating oil, and the energy absorbed in making industrial products would free consumers to shift their consumption to goods and services now beyond their reach. As the cost of basic necessities collapsed, living standards would surge.
Airlines and electric utilities, among the major oil users, would have a field day. But energy-producing competitors, like coal mines and solar energy firms, would be wiped out. Job losses and bankruptcies would devastate the energy sector, while the rest of the economy grew by leaps and bounds.
No oil price plunge is on the horizon, but the collapsing of cost of information is working in much the same way. From biotechnology to finance to the media, America's information intensive industries are experiencing stunning rates of growth. At the same time, traditional industrial organizations are going through wave after wave of downsizing and consolidation. The Sunday classifieds are choked with ads begging for workers with advanced information-technology skills, while unskilled workers have precious few options. In effect, the American economy is spontaneously reorganizing itself around the profits generated by cheap information just as it once organized itself around cheap land or cheap energy.
Like the steam engine that ended the Agricultural Age and ignited the Machine Age, the microchip deserves both the blame and the praise for these ineluctable trends. But it is not widely appreciated that the forces unleashed by the microchip dwarf even the transformative power of the steam engine. The development of a more powerful engine had only a marginally positive impact on the rate of progress in other fields. But faster computers and enhanced software help improve engines as well as all other technologies.
To recast a conventional economics term, of all technologies, it is information technology which has the highest "multiplier effect." Because better information technology accelerates the rate of innovation in every field of science and technology, and because the cost of information technology is imploding, the microchip's multiplier effect is magnified, unleashing the most powerful wave of economic growth in all human history. In a way not seen since the last great information technology breakthrough -- Gutenberg's printing press -- ended the Dark Ages and launched the Renaissance, the microchip is an epochal technology with the most profound economic, social, and political consequences. For decades to come, our economy has the potential to grow far faster than our population -- if we do not cling to outmoded economic policies that unintentionally stymie this growth.
Since economic growth of such magnitude is beyond our historical experience, it is hard to imagine. But our inability to grasp the economic implications of the microchip revolution is rooted in something more subtle than a lack of comparable experience. My own view is that most of us are blinded by an outmoded economic mindset, a worldview that we inherited from the Machine Age, a paradigm that I call "economy-as-machine."
Just consider the language that circumscribes conventional economic discourse -- on the Left as well as the Right. The economy is always "losing steam" or "picking up speed." Congress uses subsidies, taxes, and regulations to tinker with "broken market mechanisms," while the Federal Reserve "primes the pump," "fine-tunes the engine," and "brakes inflation." Indeed, every time new technology shows signs of creating too many new jobs and rewarding workers for higher productivity with higher real wages, all the experts nod and agree that "the economic engine is overheating."
The philosopher Ludwig Wittgenstein once wrote that "The limits of our language are the limits of our reality." By this he meant that human beings cannot conceive, much less discuss, an idea unless that concept has first been made accessible through language. If we don't have a word to convey an insight, that insight simply doesn't exist. How can we possibly hope to understand the nature of economic growth when we insist on describing the economy as a machine? Have you ever seen a machine grow?
At a time when mind-boggling new technologies make possible unheard of economic growth rates, we remain trapped inside a Machine Age metaphor that precludes any intelligent discussion of economic growth. As The Economist recently put it, "Economists are interested in growth. The trouble is that, even by their standards, they have been terribly ignorant about it. The depth of that ignorance has long been their best-kept secret." The culprit, in my view, is the "economy-as-machine" paradigm.
Making sense of the Information Age economy will require more than a minor revision of this old economic paradigm. We need radically new thinking. As the social commentator Peter Drucker put it in a recent Atlantic Monthly, "We need to develop an economic theory appropriate to a world economy in which knowledge has become the key economic resource and the dominant, if not the only, source of comparative advantage."
Recognizing this challenge and the inherent limitations of "economy-as-machine" thinking, I put forward a radically new view of economic life in my book Bionomics: Economy as Ecosystem (Henry Holt & Company, 1990). Bionomics argues that a market economy is remarkably similar to an evolving rainforest. Populated by organizations rather than organisms, the economic rainforest is a staggeringly complex network of feedback loops, relationships that are competitive, symbiotic, predatory, and parasitic.
Just as the genetic code inside organisms evolves through mutation and natural selection as those organisms adapt to particular ecologic niches, the technologic code inside organizations -- blueprints, databases, algorithms, check lists, and procedure manuals -- evolves through innovation and competition as those organizations reshape themselves to fit specific market niches. In the most abstract sense, both rainforests and economies are self-organizing information networks.
Neither the natural nor the economic rainforest was planned. Both economies and ecosystems evolved spontaneously. The mind-numbing complexity of each system means that neither can be planned or controlled by some central authority.
From the bionomic perspective, technological evolution is the ultimate source of all progress and economic growth. By applying an ever expanding stockpile of scientific knowledge to real world problems, human beings discover ways to squeeze better results from less input. More from less -- without limit. For example, instead of devastating the planet by smelting the mountains of copper that would have been required to create a global communications network, we've turned beach sand into microchip-packed satellites and optical fibers. In a bionomic economy, new technical know-how substitutes for labor, energy, and materials. Units costs fall. Living standards rise. In the final analysis, the growth of the economic rainforest is constrained only by human creativity.
In practical terms, however, a great new idea cannot generate economic growth on its own. Until that new idea has matured into a product that yields a stream of profits, the business organization nurturing that idea must keep investing capital its development. We see the same phenomenon in nature. Every seed has two parts: an embryonic plant and the sugar-packed tissues of the fruit that surrounds it. Until that seedling has spread its first leaves and begins producing energy from sunlight, it must draw all of its sustenance from surplus energy that was stored by the previous generation.
In the economy, the savings of families and the profits of businesses are the surplus economic energy essential to the continuing evolution of the economic rainforest. If the stream of savings and profits being recycled from one economic generation to the next is diminished, the economic rainforest of the future will shrivel.
Needless to say, the existence of taxes makes for a crucial distinction between nature and in the economy. Of course, human societies are not ecosystems. They are communities of conscious beings who have established governments to deal with problems that cannot be managed effectively through private means. Like all other organizations, governments must have revenues. Taxes imposed by law meet that need. Nonetheless, since past savings and profits support technical innovation, and since new technology is the ultimate source of rising living standards, does it make good sense to tax savings and profits as the primary source of government revenue?
Students of taxation might properly point out that companies don't actually bear the ultimate burden of taxes. Through higher prices for the goods they sell, firms shift the final tax cost onto their customers. In the end, individual Americans bear all the costs of government. Firms serve as tax collectors, but they do not actually pay taxes.
Though it is labeled an "income" tax, the federal system actually taxes potential family savings. To calculate the tax bill, total family revenues (all sources of income) are offset by various allowances, exemptions, and deductions which in effect represent the government's estimate of basic living costs. At present, tax law adjustments work out to roughly $15,000 for a family of four. Four member households pay income taxes only on revenues over $15,000, because that is when they start generating potential savings. Since tax payments could be saved if they were not taxed away, the "income" tax is, in reality, a tax on potential family savings.
Consequently, the U.S. government's single most potent economic policy is designed to discourage family savings and encourage consumption. Few Americans have much day-to-day control over their earnings. Wage levels are determined largely by one's previous investment in education and skills. But people can control how much they consume and how much they save. Teenagers decide between more stylish clothes and a larger college savings fund. Families choose between larger homes and more retirement money. Congress chooses between farm subsidies and scientific research. A single consume/save decision may redirect a few dollars or a few billion dollars, but all decision-makers face the same basic trade-off: now or later.
Of course, economic choices are rarely "all or nothing" decisions. Teenagers don't choose between no clothes and too much college savings. Few families opt for opulent mansions but no retirement funds. Economic choices are made at the margin, as decision-makers to try to find the best mix. Should your revenues be allocated 95 percent consumption/5 percent savings or 92 percent consumption/8 percent savings?
The design of the tax system is crucial to an economy's long-term growth rate, because it powerfully influences countless millions of consume/save decisions. The tax on family savings raises the effective price of those savings, making it harder to accumulate wealth. When people save less, they must consume more. There's nothing else to do with the money.
When the federal income tax was first enacted, it was a simple "flat tax" on the wealthiest Americans. But as federal spending grew, particularly after World War II, people further down the income ladder began to be taxed. Gradually, an income tax designed for the wealthy became a tax on everyone. Today, "income" taxes, together with social security taxes, comprise over 90 percent of all federal revenues. A nation that began the 20th century without taxes on household savings ended up with a government utterly dependent on such taxes.
As the income tax began to impact more Americans, the tax law's complexity grew. Today, the Internal Revenue Code and regulations weigh in at one million words and 5000 pages. On average, the law is "reformed" once every 1.3 years. Just since the 1986 flattening of tax rates, several thousand sections have been added.
Evil special interests, their Gucci-shod lobbyists, and PAC hungry politicians take the blame for punching loopholes in the tax code. But these folks are merely acting out roles made inevitable by a tax system that is based on the word "income" but works to choke off the accumulation of family savings.
Virtually anyone can make a reasonable case as to why at least some of their "income" should not be defined as taxable "income" or why some of their expenses ought to be deducted from the calculation of "income." Is it fair to treat as taxable "income" money saved for retirement? What if it's "too much" savings? What about mortgage interest? Or college tuition? Or equipment depreciation? Or research and development?
Setting a tax rate is easy. But if it's an "income" tax, the hard part is defining precisely what that rate should apply to. This is why virtually every word in the tax rules attempts to distinguish "taxable income" from "non-taxable income." Rules and exceptions. Exceptions to exceptions. This is the shadowy domain inhabited by tax accountants, tax lawyers, tax lobbyists and Congressional staffers, who like Talmudic scholars, pour over holy IRS texts, contorting the language to free their clients from tax hell.
Because an "income tax" is in reality a tax on potential family savings, taxpayers will be endlessly creative in arguing why some of their own savings should properly be excluded from the tax calculation. No matter how "flat" it is when it starts out, an "income" tax, by its very nature, must inexorably evolve into hideous complexity, political corruption and public cynicism. Year after year, the loophole-ridden income tax law erodes the public trust on which our democracy is founded -- even as it shrinks the flow of savings.
Too few of the experts seem to realize that if a tax system must be riddled with loopholes to make it economically workable and politically tolerable, then perhaps its basic design is wrong to begin with.
The only way to stop taxing family savings and end the politically corrosive effects of tax law complexity is by abolishing the federal income tax. In its place, we should enact a consumption tax; specifically, a non-regressive National Sales Tax on final retail purchases of products and services.
A National Sales Tax would end the present tax law's assault on family savings. Every dollar a family saves would be tax free. Obviously, such a radical reversal in tax policy change would have a dramatically positive impact on the national savings rate. As depicted in a frightening front-page story in this Monday's Wall Street Journal, the share of disposable income saved by American families is near its all-time low. Millions of baby boomers, only a decade or so away from retirement, have virtually no savings.
Precisely at the moment in history when stunning breakthroughs in information technology hold the promise of a great new era of American prosperity, we as a nation stand at the threshold of the future with our pockets empty. The only way to completely reverse the bias against savings, take advantage of the extraordinary investment opportunities before us, and rescue the baby boom generation from financial oblivion is by switching over to a National Sales Tax as soon as possible.
A National Sales Tax Would End the Cycle of Ever Increasing Tax Law Complexity
A National Sales Tax would not only stimulate a vast surge in family savings, it would also put an end to the politically destructive process of ever increasing tax law complexity. Forty-five states, home to 98% of all Americans, already rely on sales taxes and not one state has suffered from the creeping definitional complexity that has characterized the federal income tax system. Every final retail purchase triggers a known tax. Cash registers figure it out and merchants send it in.
Many consumption tax supporters endorse the VAT (Value-Added Tax), instead of an NST. Under this system, taxes are added into a product's price as it moves through each stage of production. Two problems weaken this approach. First, the VAT requires a large bureaucracy to handle the paperwork. Second, and more important, the VAT is buried in the price of final goods and services. The car buyer cannot tell what portion of the car's price is for the car itself and what portion reimburses the dealer for the VAT. In a democracy, taxes -- like prices -- should be clearly labeled. For a society's financial signaling system to work effectively, citizens must know how much tax they are paying for a given quality and quantity of government services.
Only a National Sales Tax offers the kind of profound, transformative change that Speaker Gingrich and his colleagues promised the American people last November. No matter how well-intentioned, any reform of the "income" tax -- whether its labeled flat, simplified, or consumption-based -- will come back to haunt those who champion it. Back in Gorbachev's time, such economic reforms were called "half-measures." Rather than face up to the need for genuine change, these so-called "reformers" sought to rescue the destructive system they had inherited. This Congress must not repeat this mistake.
If a National Sales Tax is so dramatically superior to any form of income tax, why are so many otherwise clear-thinking people so afraid of it? Simply put, because they see no way to avoid the harsh impact that sales taxes typically impose on low-income families. Since lower-income families spend virtually all their earnings on basic consumption, critics contend that an NST would be severely regressive, taxing away a larger share of the income of the poor than of the rich.
But this problem easily solved with a universal rebate. Assuming a family of four spends $15,000 (or $3750 per person) on basic consumption, at a 16% rate, the NST would cost them $2400. But that $2400 would be rebated in quarterly payments of $600. Simply listing their names and social security numbers on a postcard would qualify a family for a rebate adjusted by family size. Regardless of income level, every family would get a rebate that made their basic consumption free of federal tax.
Some older Americans argue that instituting an NST would be unfair, because they spent their whole lives paying taxes on income and now that they're only consuming, they'd be hit again. This problem is easily handled. Instead of a rebate based on the first $3750 of per person consumption, that amount could be higher for those born before certain cut-off dates. As these seniors die off, this transitional feature would disappear, and all Americans would then get a universal rebate based on the same per person amount.
With the universal rebate in place, the NST would be completely non-regressive. Taxes would be based on a clearly demonstrated ability to pay. If you splurge on that $80,000 Mercedes, you'll pay $12,800 in NST, while I pay just $1600 on my $10,000 Plymouth Neon. With elegant simplicity, the NST punishes the spendthrift while rewarding the saver.
For some, even a non-regressive NST is not "fair" enough. These critics contend that tax system must not only be non-regressive at the low end of the income spectrum, it must be progressive at the high end. And if not progressive in the sense of higher tax rates at higher income levels, then at least those with higher incomes should pay a "flat" rate on all their incremental income. Or, to put it more accurately, we should tax potential family savings and slow the accumulation of wealth. The unspoken, but widely shared belief among those who take this position is that becoming rich is somehow evil.
When Karl Marx published the Communist Manifesto in 1848, "a heavy progressive income tax" was his second priority after the "abolition of property." Marx opposed the accumulation of wealth because he saw the economy as a zero-sum game. Like some thundering steam engine, Marx's economy could only run so fast and produce so much. For me to win, you had to lose. Win-win outcomes were impossible. Income -- the accumulation of wealth -- was inherently evil, because it could only be gained by grabbing it from the weak. All profit came from exploitation. This is the very essence of "economy-as-machine" thinking.
Today, we know better. Or at least we should. Though zero-sum, class war rhetoric still shapes the mindset of liberal democrats, the Information Age economy is a positive-sum game where win-win outcomes are the norm. New wealth flows from higher performance at lower cost, a phenomenon driven by technological innovation. Newt Gingrich's recent comparison of an optical fiber and wire cable leaps to mind. More like a rapidly evolving rainforest than a steam engine, the economy is a complex, living system whose growth is limited only by human creativity and the availability of the savings needed to turn new ideas into reality.
Rejecting Marxist envy and zero-sum, Machine Age thinking, the moral message conveyed by a National Sales Tax is, "No matter how rich you get, if you continue to save and help grow the economic rainforest by financing new technologies and jobs, you'll pay no tax. You only pay when you take resources out of the economy and consume above a basic level."
If Congressional leaders truly mean it when they promise Americans a new "Opportunity Society," they must begin by eradicating the federal income tax. Notwithstanding Karl Marx, there is no shame in getting rich. There is only shame in "reforming" an income tax designed to prevent all Americans from doing so.