“Why do I begin with taxation?” probably because that is where this country started. We focused, as a fledgling nation, on the issue of taxation without representation. Taxation was, and still is, a basic issue of fairness to drive us to a common goal as a people.
The role of taxation is to provide for the common good through the collective contribution by society. Normally we focus on taxation as being compulsory. However, if taxation is to be effective in causing us as a people to bring about a society that values its collective needs and responsibility, then every citizen must see taxation as a provision we all support to lead us to a common good.
If we focus first on the common good, then the collective contribution becomes fairly easy to solve. However, most of the time we focus on the “collective contribution” rather than the motivation behind having taxes in the first place. The common good is properly identified as those areas whereby government can assume a large degree of similar motivations that call to our basic needs for collective action to be successful. The common good, being broad based, would lead us to correctly identify sources of revenue as one in which all Americans are expected to contribute. Taxes to support our military, court system, and general government operations are good examples of what is a common good. We all agree that without these basic services, we as a nation would not function as a single country. The principle that we should have a common tax for supporting the common good is a foundation of fair taxation.
The second area of consideration is where we have a specific good that the government feels comes under the general commerce clause of the constitution or other areas that require us to identify the specific need and how to fill it. The U.S. Highway System is a simple example of where we have a strong collective will to share the benefit of a road system that ties all of the states and major cities together for increased commerce, safety and freedom of movement.
If we had instead focused on the “gasoline tax” before we recognized a specific good then there would have been, most likely, severe opposition to such as momentous a task as the forty year effort to build our modern highway system. Once it was agreed that a common benefit was to be provided, then we just had to decide how to tax ourselves to pay for this good.
It was decided, in what I considered a brilliant move, to tax fuel since virtually all of the vehicles on the highway would be benefiting from the highway system. This tied the benefit reasonably well to the consumer of the good, and thus the cost for that benefit. This principle, to charge the consumer of the governmental service for the benefit provided, is the first step in correctly identifying how to tax for specific services fairly.
Though we will always have a need for taxing the public for the general welfare of the nation for defense, the courts and general operation of the government, we should try as much as possible to charge for those services that can be traced to a specific group of users. Examples would include the cost of entrance into parks to fully charging for any natural resources provided to private companies.
These two principles will be the basis for further discussion in how we should tax ourselves. Let us turn to taxation in general. As a nation founded upon the idea that men are equal before the law, the tax code is the most capricious and unequal law that we have yet devised. It segregates us based on income, influence, industry, social structure, age and even with whom we associate. Therefore, it has lost much of its validity in promoting a society that will treat each person justly and fairly. Furthermore, it has reached so heavily in to our lives that it causes great resentment between fellow citizens and thus can lead to extreme selfishness and ultimately promotes social disintegration.
Let us now look at taxes for the common good. Broad based taxes generally come in two forms. The first is a form of consumption tax. A national sales tax would be a prime example. The sales tax is appealing because it allows us to have a simple and convenient way to collect taxes and avoids direct interaction with the electorate. However, it is a bad tax for at least two fundamental reasons.
Let me give an example of how it is applied differently than an income tax to show the lack of fairness. An income tax is based upon the idea of a common tax applied over a common time period. Ideally the only fair income tax is a flat tax. God deemed that every one should pay a flat tax so that each person is taxed according to what each was given. Thus, as a percentage of income it was levied on all peoples (full participation) but still in proportion to the ability to pay.
In our example let us assume two individuals with an income of $100,000 and $10 million in income. Let us assume either a flat income tax of 15% and standard deduction of $20,000 or a sales tax of 15%. The person with the lower income spends 80% of his income while the wealthier person spends 20% of his income. The tax burden on each would be as follows:
Sales Tax
1. $100,000 income X 80% spending X 15% sales tax = $12,000 in tax or 12% effective tax rate.
2. $10 million income X 20% spending X 15% sales tax = $300,000 in tax or 3% effective tax rate.
Income Tax
3. ($100,000 income - $20,000 deduction) X 15% income tax = $12,000 in tax or 12% effective tax rate.
4. ($10 million income - $20,000 deduction) X 15% income tax = $1,497,000 in tax or 14.97% effective tax rate.
Clearly, under 1 and 3 the family with the lower income pays the same tax. However, the very wealthy pay very little tax under the sales tax proposal (2) and will not pay tax on those earnings until either he chooses to spend more money or he dies and any untaxed income will be subject to some sort of “death tax”. In either case, the principle that “taxes are owed when income is earned” would be violated under a consumption tax proposal.
Further, when we have deductions that are a function of specific working capabilities we are discriminating against our fellow citizens. If you are self employed and you contribute to a retirement account, it is entirely self funded. However, if you are employed by a company, contributions to you can be tax deductible and not recognized as income. This is what causes the great distortion in private health insurance. Those companies that provide and pay for a portion of health insurance are giving a tax free benefit while self employed persons must pay with after tax dollars. Discrimination, whether in race or money, is still wrong.
A fair tax proposal would be like the following:
1. A flat single tax rate. Experts expect this to be between 15% and 20%.
2. A single deduction for each household based upon the published poverty rate. Tying taxes to income above poverty makes more sense than to tie it to income above an arbitrary indexed number. I would propose that this be set at 2.5 times the poverty rate, adjusted annually for changes in the cost of living. For a family of four the current poverty rate is about $16,000 so 2.5 times that rate would be a deduction of $40,000. For a single person this would be about $24,000.
3. No other deduction except for catastrophic loss above 50% of income. This could cover illness, natural disasters, etc.
This would be fair, understandable and easy to monitor. We would abolish all deferred income plans, all delaying of taxes due to distortion of who could save for retirement, etc. There would be no need for expensive attorneys to implement trusts or deal with inheritance taxes because all taxes are due when the income is earned. The only issue is what to do when appreciated property is passed on to another generation. In that case the principle is quite simple; the persons receiving the property must take it at the original basis. Thus when it is turned into income through sale or disposition, tax will be due on the previously untaxed income.
Let us say that a couple has purchased a farm for $100,000. At the end of 10 years the couple dies and passes the estate on to their daughter. She operates the farm for 20 more years and then sells it. If she sold the farm for $2 million, then her tax would be calculated as follows:
($2 million sale price - $100,000 basis) X 15% tax rate = $285,000 in taxes.
The issues this would solve are extensive. Let us look at the impact this would have on society. A list of a few advantages is:
1. Since all income is taxed and no one can have income paid for by there company without recognizing the benefit as taxable income, there is a completely level playing field between self employed and corporately employed individuals. This could dramatically alter the landscape with respect to insurance, retirement, etc. It would give incentive to employers to stop trying to provide benefits that are of little value to some and of greater value to others and instead let each person purchase those benefits either through or outside of the employer. I will discuss this in more depth later. Suffice it to say that we would finally give individuals the ability to leave an employer without fear if they knew that they were not bound by a benefit that they could not get elsewhere.
2. Subsidies that favor some industries over others would be eliminated. Such examples are foreign export subsidies that benefit a few corporations and the oil depletion allowance. The oil depletion allowance is an especially troubling tax credit because it has no basis in real economic benefit to anyone except as a way to avoid taxes. If congress chose to give a benefit to a particular industry rather than give a hidden benefit through a targeted tax reduction, they would have to appropriate the money and write a check from the U.S. Treasury. The use of tax credits over the years to provide special incentive to specific organizations has been one of the most abused forms of power we have ever seen. Congress has refused to recognize that the general principle of only providing specific benefits when there is a clear and compelling reason to fulfill one of there constitutionally mandated responsibilities is one of the reasons we read about scandals involving lobbyists. Congress should be required to be transparent and only grant benefits that impact less than 50% of the population by direct grants from the Federal Treasury. This exposure to the light of specific expenditures would allow for both transparent government and accountability for the “pork” currently doled out through creative tax benefits.
3. Elimination of the enormous burden on both the Internal Revenue Service to create extensive regulations and the taxpayer to pay high priced experts to try and work through the thousands upon thousand of pages of special legislation in our tax code.
4. A perception of fairness that would eliminate the continual discord between parts of the population, thus creating social discord. Why should a couple, in there peak earnings years immediately prior to retirement and when they are most focused on saving money, be subject to twice the income tax rate of a very wealthy who have billions? This polarizing and destructive force in our society is great for driving the political parties but terrible for creating a social fabric in which we all pull together to deal with the truly pressing moral, social and economic issues of our day.
5. A simple tax that would allow both corporations and individuals to plan for the future with some degree of confidence as to how they should handle there affairs. Today we have all sorts of extra burden to keep up with the passing fancy of lawmakers to add or reduce taxes.
One issue that routinely comes up is how we would redefine income and measure it during the transition period. I think it could be done quite simply with a few simple rules.
All income would immediately become taxable at the time of implementation of a flat tax. To avoid company’s from reducing an employee’s take home income, all prior non-deductible or company paid expense would need to be added to the employee’s income with penalty of jail time for defrauding the public. For example, an employee might see the following changes on his pay stub.
1. Prior to conversion
a. Income $2,000
b. Employer paid Social Security $ 150
c. Employee paid Social Security $ 150
d. Take home pay before tax $1,850
2. After conversion
a. Income $2,150
b. Employee paid Social Security $ 300
c. Take home pay $1,850
Of course there would be a change in tax rates since now all income would be taxable. This plus the change due to other tax reforms covered later could make the tax landscape so simple that there would be no inherent unfairness due to having a “brilliant” tax advisor that could find all of the loop holes. Confidence in the system would be restored.
We consolidate all special treatment tax accounts into a lifetime savings account. One objection to a flat tax is that there is no deduction fro retirement income, college, etc. This is quite simple, instead of allowing folks to save pre-tax, we would allow them to save with no future taxes on there earnings. Thus, just like the ROTH IRA, all dollars contributed would be after tax but all withdrawals would be tax free up to a certain limit. There should be no income test with this single lifetime savings account. The tax free withdrawal should be limited to a cap of $1 million gain, indexed to inflation. By example we might have an individual contribute $10,000 per year for 40 years. At the end of 40 years they have an account worth $2.0 million. They could withdraw the principle of $400,000 tax free since that was put in with after tax dollars. Then they could withdraw another $1 million tax free. The remaining $600,000 would be taxed at the normal tax rate.
This proposal eliminates a number of issues with the current mix of accounts available today. First, there is no income test so self employed individuals who do not bring home an income would not be penalized. My wife spent 16 years home schooling our children but was denied the right to set aside the same amount of income in an IRA than she would have been able to set aside if she qualified for a 401K plan. This discrimination meant she will be denied the same ability to retire even though she saved the public school districts hundreds of thousands of dollars in teaching our children.
Second, by having one account, individuals could avoid lots of small accounts, each with various fees, which keep the small saver from getting ahead. Just the basic IRA fee of $15 could have a cumulative effect of being worth several thousand dollars over a working career, much less for other accounts such as 529 plans, etc.
Third, by placing a maximum on the amount of tax free withdrawal, indexed to inflation, there is fairness between individuals regardless of when they earned there income. Today we cap the amount of savings on a per year basis. However, life is not a simple straight line. It is complicated and messy. Some years you get a good bonus and others you are scraping by with the payments. By allowing merely a lifetime maximum of tax free withdrawal, you eliminate the penalty towards those whose income is unpredictable, such as in sales or other profession where there income is more entrepreneurial.
Fourth, all income is treated the same. There are no classifications like “long term capital gains” that allows the wealthy to pay a lower tax while penalizing the basic wage income earner. One of the most oppressive aspects of our current tax system is that when a couple are in there peak earning years, usually in there 50’s, they often are paying a tax rate over twice that of the super wealthy. We all know that the very wealthy can afford to invest for there earnings and thus can derive the vast portion of there income from capital gains. Thus the very wealthy will pay 15% while the higher earning person in the last few years of his working career is often paying a marginal tax rate of 35%. It has been said that we need the 15% tax rate to induce individuals to invest in new business ventures. This has been shown to be absolute baloney! When Bill Gates started Microsoft, the marginal tax rate was substantially higher than 15% and yet he still co-founded his company. Good ideas, not tax policy, create wealth. This unfair treatment of wage earners is one of the prime reason no one trusts
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