Anyone could come up with a better tax system than we have in the U.S. It is - to start - horribly complicated. I suspect that it is deliberately complicated to make it difficult to see how unfair it is.
Complexity is also very costly. The Tax Foundation estimates the labor cost of complying with the current tax code at 22% of U.S. tax receipts.
Rather than trying to fix the system, we will design a new one from scratch. We will call it . . . the Income Tax.
Taxing Income Rather than Consumption
Yes, it will be an income tax rather than a sales tax or a value-added tax, which are collected from businesses rather than individuals. The reason I am going with an income tax is that it allows us to avoid taxing people whose incomes are at or below the poverty level. We don’t want to tax people into poverty. With an income tax, we can avoid taxing the poor by using personal exemptions. For example, if the poverty level for a family of 4 is $20,000, the personal exemption would be $5000. For a family of 4, only that income in excess of $20,000 would be taxed.
Personal exemptions protect low-income people from the income tax in the current system, but they still get hit with the social security tax (FICA), which is a hefty 12.4% (6.2% paid by the employee, 6.2% paid by the employer). Roughly 80% of taxpayers pay more payroll taxes than income taxes. Young families are being forced to save for retirement when their money could be better spent on education, or to feed their children. In my system, there will be no social security tax (see Reform Social Security), so there will be no tax at all on incomes below the poverty level. And since there will be universal health care (see Guarantee Universal Health Care), there will be no reason for anyone to choose welfare over work, even at a low wage. Low-paying jobs that are turned down currently by all but immigrants will be filled by U.S. citizens who otherwise would have been on welfare. As a result, both welfare costs and illegal immigration will be reduced.
Except for the income protected by personal exemptions, all income will be taxed. There will be no deductions, no loopholes, no tax shelters. All income will be taxed at the same rate.
One reason I am against a progressive tax rate is that it is more complicated. Another is that I don't think it is fair to make people pay at a higher rate just because their income is higher. They already pay more because the tax is a percentage of their income, so increasing the rate makes it increasingly unfair. Income is, after all, a measure of production, and the fact that a person produces more does not mean that he uses more government services or has an obligation to those who produce less.
Advocates of a progressive rate might argue that people with high incomes are able to avoid taxes by hiring accountants to find tax loopholes and tax shelters. With the new tax, however, there will be no loopholes or shelters. People might also say that people with high incomes don't really deserve the money they earn because they get it by taking advantage of some privileged position, or they cheat or steal or take unfair advantage of others. If that is so, the tax system is not the way to correct the situation, because the penalty would also be applied to those who earn their high incomes legitimately.
I think the real reason liberals like a progressive rate is the reason John Dillinger gave when asked why he robbed banks: Because that is where the money is.
There will be no tax deductions. The traditional deductions for such items as mortgage interest, medical expenses, property taxes, charitable contributions and Individual Retirement Accounts (IRAs) will no longer be allowed. In addition, contributions to employer-sponsored retirement plans will be fully taxed. This may sound cruel, but it’s not. We can have a fair tax, where everyone pays the same percentage of his income, or we can have deductions. What we lose with no deductions will be gained back with a lower tax rate, and we will all be confident that no one is getting away with paying any less than the rest.
As a group, taxpayers never gain anything from tax deductions. To think otherwise is a delusion. In the end, we together have to come up with enough to balance the budget. The amount we have to come up with depends solely on how much the federal government spends. We can control how much government spends, but as far as taxes are concerned, we can only choose whether to come up with the money in a manner that is fair to everyone or one that forces some of us to pay extra so that others can pay less.
To insist on a tax deduction is immoral. It is simply a way to screw your neighbor.
While individuals benefit from tax deductions at the expense of their neighbors, certain industries also gain. They include the investment industry, banks, charities, churches, the insurance industry, and the real estate industry. More on that later.
From the federal government’s standpoint, tax deductions can be viewed as tax expenditures. When taxpayers are allowed to deduct an item from taxable income, they receive - in effect - a government subsidy. If my marginal tax rate is 24% and I claim a deduction for a $1000 charitable contribution, my tax is reduced by $240, which is the same as receiving a $240 payment from the government. The federal government understands tax deductions to be subsidies and actually refers to them as “tax expenditures”. As part of the federal budget process, tax expenditures are identified and listed along with their cost. My source for much of what follows is a document titled Estimates of Federal Tax Expenditures for Fiscal Years 2010-2014 prepared in December 2010 for the House Committed on Ways and Means and the Senate Committee on Finance. It can be downloaded here. It defines tax expenditures as
Following are the tax expenditures that are expected to result in revenues losses of over $10 billion in 2011.
Getting rid of all tax deductions need not increase total tax liabilities. To keep this reform “revenue neutral”, elimination of the deductions could be offset by a decrease in tax rates, allowing us to continue enjoying budget deficits in excess of $1 trillion (at the expense of our children). It would, however, result in some huge changes. Here are a few examples:
Floating Tax Rate
The tax rate would float. The rate would be whatever is necessary to balance the budget. Every piece of legislation would be required to include a price tag, an estimate of the change in tax rate required to keep the budget balanced. Rate adjustments would be made periodically – quarterly, maybe. Folks who want to “starve the beast” by reducing taxes would no longer be able to do so. If they want to reduce government spending, they will have to do so directly, by cutting programs.
No Corporate Tax
There would be no corporate income tax. Taxes on business are unfair because they just get passed on to the consumer, and the amount passed on is not based on ability to pay. Corporate profits will be taxed, but only as income to the owners/shareholders. Corporations will be required to distribute all profits quarterly.
In case you didn't catch that, I said that corporations will not be allowed to keep any of their profits. They will distribute all profits to shareholders, and the shareholders will be required to pay taxes on those distributions as part of their individual income. All income will be taxed, and it will all be taxed as individual income.
If you are concerned that this required distribution of profits deprives the corporation of capital it could use to reinvest - to finance new equipment, open new plants, or do research - my answer is that the corporation will have to get that money by borrowing. It will have to convince prospective lenders that the investment is sound and that the money will be repaid - with interest.
Limiting Business Expenses
Since they must be subtracted from gross proceeds to determine a business' profit for tax purposes, business expenses must be clearly defined. Not recognizing legitimate business expenses makes profits seem higher than they really are and unfairly increases the business' tax liability. On the other hand, allowing a business to claim expenses not related to the production and delivery of its product reduces its tax liability and forces other businesses and individuals to make up the loss in tax revenue. It also has the effect of subsidizing the purchase that was claimed as a business expense. To illustrate, let's say that I am a homebuilder and my profit for the year is $100,000. The tax rate is 24%, so my taxes are $24,000. Just before the end of the year, I spend $1000 to entertain some legislators who are considering a bill that will affect the home building industry. I claim it as a business expense, so it reduces my profit to $99,000 and my tax decreases to $24,660. In effect, entertaining the legislators only costs me $660. The government pays the other $240.
I would limit business expenses to those necessary to the production and delivery of the product, fully aware that there is going to be a lot of disagreement about what expenses are necessary. This will be a very complicated aspect of an otherwise simple income tax. A permanent agency or commission would be needed to establish guidelines, respond to inquiries and settle disputes. Decisions will be made on the basis of what is good for the country, not what’s good for business - keeping in mind that a healthy business community is good for the country.
The big item that would no longer be allowed as a business expense is advertising, on which $290 billion is expected to be spent in 2007. It is so big that I’ve addressed it separately (see Stop Subsidizing the Advertising Industry).
The IRS will be fair, firm and fully funded. It will be allocated all the resources it needs to make sure that everyone pays his fair share. Every taxpayer can be confident that he is paying no more than anyone else, unlike in the current system in which the IRS is under-funded and the gap between taxes owed and taxes paid is estimated at $345 billion. Also, the IRS won't be giving away $1 billion in fraudulent refunds, like they did in 2007.