Caution: long post….
President Obama and his Progressive Democratic Party insist that all of us should pay our “fair share” of the nation’s tax requirement. I agree: all of us should pay our fair share. The top 10% of Americans by income paid nearly 70% of the total personal income taxes collected by the Federal government in 2008, while the bottom 50% paid nearly 3% (that’s no typo) of the total in 2008. Further, the rich may be getting richer, but they’re also paying more in income taxes. In 1999, those top 10% paid a little over 66%, and the bottom 50% paid 4% of the total.
It’s time to reform the tax code and make it easy for all of us to pay our fair share. In 2007, according to Census Bureau data collected from IRS-aggregated Form 1040 filings, Americans earned $17.8 trillion dollars from all sources: wages and salaries, interest payments, dividends and capital gains, gambling earnings, pass-throughs from their small businesses, and so on. According to Government Accounting Office data for that year, Americans paid an aggregate of $1.15 trillion dollars in taxes on that income. The present tax system is perceived as unfair by all participants, and they have arguments for their views. Progressives view the rich, paying 70% of the total tax receipts, as not paying enough to be fair. On the other hand, modern Conservatives consider that the bottom 50%, paying little to no taxes, also to be not paying enough. Further, the complexity of our tax code is proverbial; not even professional tax accountants understand it well, and the IRS’ own advisors often provide erroneous help to inquiring taxpayers.
Our personal income tax code should be simplified, with the various filing statuses and tax brackets replaced with a single filing category and tax bracket. Each household should pay a single, flat rate: all income above a level equal to half the then-current year Federal Poverty Income Guideline should be taxed at a rate of 10%.
Tax breaks, tax subsidized transfers, deductions for this or that expense—including the mortgage interest deduction and medical expense deduction—should be eliminated. Note that this will include the standard deductions for family dependents; the Poverty Guideline includes an adjustment for family size. Further, the elimination of all those deductions, credits, exceptions, and so on will greatly reduce the ability of special interest groups, and of politicians generally, to manipulate the tax code for their own ends. The removal of the market distortions created by using tax policy for social engineering and wealth redistribution will lead to falling prices for those subsidized goods, and it will make it easier for all participants in the market—we Americans—to make our own decisions. Finally, this equal percentage paid by all still leaves the actual dollars paid in taxes quite progressive: a man making $20,000 per year above that exempted income amount will pay $2,000 in Federal income tax. A man making $200,000 per year above that same exempted income amount will pay $20,000 in Federal income tax.
The present corporate tax structure leads to the following distortions (among others) of business incentives in the United States: because it is imposed on income from capital, it biases decisions about how much to save and therefore influences overall capital investment and business growth. It also creates a bias in favor of financing through the use of debt. Further, because the law treats a corporation as a separate taxable entity, from which shareholders subsequently receive a portion of their income in the form of dividends or capital gains, the relatively beneficial tax treatment of capital gains under the personal income tax code creates a bias against paying dividends. Finally, because the corporate tax code also uses schedules for depreciation that do not correspond to real wear and tear on equipment, it creates a bias in investment and production toward those capital assets more lightly taxed.
From these high, complex, and in some cases unrelated to reality, tax requirements, we can see that our corporate tax code discourages foreign companies from investing in the US or from setting up branches of their operations in the United States (known as “insourcing” in the same way American companies sending work outside the US is known as “outsourcing”). Our tax code also creates incentives for American companies to build their new branches in other nations with lower corporate tax rates (Ireland, for instance, before it was dragooned into accepting an unneeded European Union bailout, taxed corporations at 15%). Both of these incentives tend to reduce employment in the US, since the companies involved opt for foreign locales.
It’s time to apply a flat tax to corporations, also, and that corporate rate also should be 10% of all income (note that, even though the government and the Courts have said that corporations are “persons,” there are no Federal Poverty Income Guidelines for corporations, thus there is no income exemption here), both domestically earned and foreign-earned. Tax subsidies, deductions, credits, and so on should be eliminated. The elimination of these will have the same decision-making outcomes and economic effects as their elimination from personal income questions: the biases will disappear, and free market participants will make their own decisions.
To be sure, there will be disruptions in various markets while the changes ripple through the economy, but with the simplified code, compliance will increase (an increase in revenue for the government), and more importantly, the net result of the elimination of the market distortions will be a small decrease in overall prices that will go along with wages and salaries that have not dropped commensurately (wages do not fall at all as rapidly or as easily as do market prices).
There have been suggestions of having a national sales tax in lieu of any sort of income tax. A tax on consumption would amount to everyone paying “their fair share,” and it would represent a great simplification of the Federal tax code. The simplification argument could certainly be true. However, a consumption tax would hit the poor much harder than it would anyone else. Some consumption is absolutely necessary and cannot be avoided. Everyone must buy food, everyone must make rent or mortgage payments, everyone must pay transportation costs of some sort. A tax on these necessities would be a cost to the poor disproportionate to the costs others are paying: a consumption tax is regressive; there is nothing flat about it at all, in any way.
Some will argue that the poor could get a tax refund at the end of the year, based on some rule for refunds, just as income tax refunds are available now. This, though, does not address the current tax burden that they would have to suffer for an entire year before they could get that refund. Their cash flow would suffer, and later remediation would do nothing to eliminate the ongoing pain.
Others will argue for not taxing food, or fuel, or rent payments. Making such exceptions, though, would only be the camel’s nose in the tent. There are always worthy causes that should receive special tax treatment. If we start making such exceptions, we will very shortly have a consumption tax code every bit as Byzantine as our present income tax code.
Yet others will argue that a flat income tax is itself regressive, and more so than a consumption tax. However. A tax on income does not hit those who do not work, but must still buy necessities. A tax on income, in fact, is completely independent of the market choices anyone makes. Compare, also, the amount of consumption taxes paid by the two men in our example above. Let’s assume, for the sake of argument, that actual necessities—food, housing, and transportation, for instance—cost $18,000 per year. Let’s assume, further, that comfort-level expenses—dining in restaurants, a better house, a fancier car, a better entertainment system, music and movie DVDs, for instance—cost an additional $18,000 per year. Finally, let’s assume a consumption tax rate of 10%. Our man making those $20,000 above the exempted amount is going to pay all of those $18,000 for necessities—those expenditures are unavoidable. Let’s assume that, as a responsible adult, planning for his family’s future, he splits his remaining $2,000 of income between savings and comfort-level expenses. His sales tax bill, then, will be 10% of $19,000, or $1,900: a slight reduction in his tax bill compared to his flat tax bill. Let’s say our man making those $200,000 above the exempted amount buys all of those comfort-level items in addition to the necessities; his consumption expenditures, then, are $36,000, and he has a consumption tax bill of $3,600. He’s paying less than a fifth of his flat income tax bill. Indeed, our “rich” man would have to spend, voluntarily, 95% of his income on consumption alone—as our “poor” man had to do—in order to have the same relative consumption tax bill.
Tax reform is a flat tax.