CRS EVALUATES 'PAR USER'S FEE.'

Among numerous proposals advanced to raise Federal revenues recently is to place a tax on the value of almost all financial transactions. It is called a "par users fee." Its author, John A. Newman, has presented it to the Congress and the public finance world as a means of deficit reduction relying automatically on the modern computerized financial system. This report analyzes the salient features of such a possible levy.

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Proposals to cut the gigantic Federal deficit have ranged far and wide. Among them is an innovative suggestion to levy a new Federal tax that would be broadly based: the proposed "par user's fee." As developed by tax lawyer John A. Newman, it would collect a small sum from all checks, direct deposits, and many other noncash transfers of funds through the banking system. ¹ The proposal is presented and analyzed below.

DESCRIPTION OF THE PROPOSAL

Revenue Base

Most economic activity in the United States is mirrored in financial transactions flowing through the banking system in the form of checks, drafts, electronic funds transfers. Each stage of the production and sale of a good or service in the economy generally requires numerous financial transactions (loans, other capital transfers, payments to suppliers of labor, raw and intermediate products). Except for those handled by barter or cash, most transactions go through the U.S. bank clearing system. The sum of all these financial transactions is a very large number, many times larger than the gross national product. Mr. Newman has estimated it as $220 trillion. ² This sum represents money moving into and out of various financial accounts, and for banking purposes there is a record of each such movement. This is the base that Mr. Newman proposes to tax.

The tax would be levied at some very low rate -- Mr. Newman suggests one-two-hundredth of 1 percent, or .00005 -- on each transfer out of an account with a financial institution. Interbank clearances and certain interaccount transfers would be exempt. Cash movements would likewise be exempt. Government transfers would be taxed on their DEPOSIT rather than their withdrawal (i.e., taxed to the recipients instead of the governments, as an exception to the general collection rule). The bank handling the account involved in the taxed transaction would deduct the required tax from the account and remit it to the Federal Government at the same time that it deducted the principal amount from the account, making collection virtually automatic.

Is It A User Fee?

The proposed tax is called a "user fee" by its author because it is levied on a financial system created and maintained by the Federal Government. Mr. Newman suggests that it can be viewed as a fee for the services provided by the Government in clearing transactions, and insuring deposits. Mr. Newman characterizes his fee as a "par" fee in return for the Government ensuring acceptance of checks at 100 cents on the dollar (par), without recipients worrying whether the instrument would be redeemed at par by the issuing bank. This terminology stems from conditions in banking that existed many years ago, when bank liabilities issued in one location were subject to discounts if presented elsewhere, i.e., "nonpar" valuation for their presenters.

In most tax literature, "user fee" means a government charge related to the cost of providing the government services, analogous to a price in the private economy. The charges presently levied against financial institutions for Federal deposit insurance, wire transfers, and the like by their regulators are "user fees" in this sense. Mr. Newman's proposed fee is in addition to the present fees and is intended to raise revenue for general Government use, not to reimburse specific Government costs.

Indeed, to the extent that Federal legislation (beginning with the National Bank Act of 1863 and continuing through P.L. 96-221) has forced depository financial institutions to maintain cash reserves to, among other things, facilitate the clearance of payment instruments, some would suggest that they already more than compensate the Government for such services by submitting to a large implicit tax: lost earnings on the reserves. This "reserve tax" seems to be largely passed onto customers in the form of service charges and lowered or zero interest on checking accounts. ³

ARGUMENTS IN FAVOR

Mr. Newman estimates the base for his proposed "user fee", the sum of the transactions clearing the banking system annually, as "at least $220 trillion." (CRS is unable to verify this estimate independently.) Clearly, the proposed tax base is very large. A very large base can be combined with a very low, unobtrusive tax rate to produce large Government revenues without unduly upsetting taxpayers. Very low rates make evasion and avoidance unprofitable activities for most taxpayers, as was the case in the successful collection of Federal "stamp duties" on many financial transactions in the 1860s. ⁴ The levy would not likely be large enough (at Mr. Newman's suggested rate) to induce many payers to shift to barter or cash payments and the "underground economy."

The tax would be a very easy levy to collect. The bank doing the final processing of the transaction would simply program its computers to deduct from the account the amount transferred in the transaction. Remittance could then easily be made to the Treasury's tax and loan accounts that are presently maintained within the commercial banking system. The financial community could be allowed to retain a small portion of the amounts collected, perhaps 1 percent, for serving as collection agent. ⁵ The entire system could operate virtually automatically for most routine transactions. Most recipients would thus not feel the imposition of the "fee." The payers would probably treat the small sums deducted as a nuisance only, of even lesser irritation to them than sales taxes.

The extensive records presently maintained in the banking system would be adequate to allow Government verification and audits of the tax collection system. Unlike most other new tax proposals, no elaborate new system of administering the tax would be required, at least for those transactions that stayed within the present bank clearance system. The low proposed rate of tax would make extensive efforts to avoid the tax uneconomical for most smaller transactions, further simplifying the administration and enforcement problem.

Changing the rate of tax would be a fairly simple matter that could be accomplished quickly (at least as an administrative problem) by merely notifying the banks to change the rate in their computer programs. If quick rate changes for fiscal policy reasons were politically feasible in this country, this tax could certainly be designed to accomplish this purpose easily.

ARGUMENTS AGAINST

For taxpayers with large aggregate financial transactions (i.e., major corporations), even a low rate of tax can be profitably avoided if the cost of avoidance is relatively small. Since this tax would strike only transactions clearing through the U.S. banking system, it could be avoided by dealing in cash, by barter arrangements, or by conducting the transaction through foreign banking systems. Extensive efforts to prevent this type of avoidance could lead to far greater administrative costs; but the possibilities for avoiding the tax could reduce considerably Mr. Newman's estimated tax base of $220 trillion.

Another possibility for avoiding tax law, and thus reducing the tax base, would be vertical integration of operations. Payments to outside suppliers go through the banking system and thus would incur the tax; the same item supplied from within the corporation could avoid the tax. This is a common effect of European-style "turnover" taxes, gross receipts taxes, and other taxes that, like this one, can be decreased by decreasing the number of transactions involved in an operation.

This tax base may be somewhat overstated in another sense, also. The base is so very large because it counts the same dollars over and over again. Gross national product (GNP), the final market value of all economic transactions, is around $4.5 trillion; financial transactions totalling $220 trillion are the sum of many turnovers of the dollars making up GNP, as well as many movements of capital and financial paper that do not add to GNP. In other words, the $11 billion tax increase proposed by Mr. Newman must come from the $4.5 trillion GNP, just as any other tax increase must, regardless of the tax base; and it is the same percentage of GNP as any other $11 billion tax would be, regardless of the stated rate. The $11 billion is almost exactly one-quarter of 1 percent of 1987 GNP. In absolute dollars, it is essentially the same amount as the revenue shown in the 1987 budget from the Federal excise taxes on tobacco and alcohol. ⁶ The continual absorption of small sums from the circular flow of dollars reflecting ongoing transactions becomes clearer in chart 1 (on the next page -- the spatial relationship of the 5-cent deduction from the $1000 circle is clearly not to scale).

The fact that this proposal would tax the same dollars again and again as they move through the economy makes it difficult to determine the final incidence of the tax. The tax represents an increase in the cost of doing business for business taxpayers, and it may be assumed that the tax, like other costs, would be passed forward in price increases whenever possible. Since the tax is on financial rather than real transactions, however, its impact on the final price of any good or service depends on the number of financial transactions it takes to make each purchase at each stage of production (e.g., a check to purchase an intermediate good from a supplier, a check from the supplier to the earlier stage input supplier, checks for loans to cover each item used, and so on for each stage of production and final sale of each product). If the accumulated tax on all such transactions is ultimately passed through to final consumers, the tax would be the equivalent of a sales tax on all goods and services levied at a rate (expressed as a fraction of final sales price) considerably in excess of the stated rate of .00005. In the case of the stamp taxes of the 1860s mentioned above, for example, final product prices rose by many times the totals of the per-item intermediate-stage taxes. ⁷

Politically, the relatively "hidden" nature of the tax and the ease with which its rates could be raised would not be regarded as positive points by everyone. Some prefer to have taxes that are not easily ignored as a means of imposing fiscal discipline on Government activities.

         CHART 1. Movement of $1,000 Through the Economy and

The proposal has appealing features. Its very low rate, making the tax virtually unnoticeable by most taxpayers, combined with the very large base, many times GNP, could possibly produce large amounts of revenue fairly painlessly. It would rely on a well-established system of electronic records and thus could be an easy tax to collect.

The proposal has disadvantages in that: (1) transactions could be structured so as to escape the tax (cash, trade credits, asset swaps) on very large transactions; and (2) the tax would increase business costs and thus could be presumed to increase the price of goods and services throughout the economy. The rate of price increase, however, would depend on the financial transaction involved in the production and sale of the products, since each separate financial transaction increases the total tax bill. This "cascading" effect makes it very difficult to determine upon whom the tax really falls. If it is ultimately passed through each stage of production as price increases, as the similarly cascading turnover taxes often used in Europe are, the tax would ultimately be borne primarily by consumers.

² Ibid., p. 1008.

³ The banks' reserves are invested by the Federal Reserve System in its own portfolio holdings of Government debt, thereby generating about $16 billion of operating income for it yearly. This giant sum is not returned to the banks, but is used by the Federal Reserve to fund itself and make contributions to the U.S. Treasury as "interest on Federal Reserve notes."

⁴ Studentski, Paul, and Herman E. Kroos. Financial History of the United States. New York, McGraw-Hill, 1963. p. 149, 167.

⁵ Financial institutions would have to be sufficiently compensated for their start-up and continued programming costs to overcome their basic opposition to such a burden on their operations. Their efforts to end conceptually similar congressionally mandated collection of withheld taxes on interest and dividends, scheduled to being July 1983 by P.L. 97-248, resulted in its repeal by P.L. 98-67.

⁶ Executive Office of the President. Office of Management and Budget. Budget of the United States Government, Fiscal Year 1988. Washington, Govt. Print. Off., 1987. p. 2-4 and 5-18. Percentage calculated by CRS.

⁷ Studentski and Kroos, p. 152-153.