Saturday, January 3, 2015

CAN A FLAT TAX BE A FAIR TAX? COULD BE...

One of the issues that falsely divides us in a variety of ways is the question of taxation. I'm not going to get into a critical discussion of supply side economics or the value of various incentives written into the tax code to the benefit of individuals or businesses. That way lies madness. I'm going to simply discuss how a flat tax on individual incomes can be structured to be easy and economical to enforce, progressive in its way, and equitable.

Why should this discussion divide us? If there's a cheaper and fairer way to fund our government, why shouldn't we be diligent in our exploration of it? There are three main reasons comprehensive tax reform has thus far failed to make progress. Briefly:

1. Folks at the edges of both political parties have championed a flat tax. When both Jerry Brown and Malcolm Forbes think that something is a good idea, there's gotta be a catch.

2. CPAs, lesser-credentialed tax accountants and preparers, purveyors of tax software, IRS workers, elected members of Congress on powerful committees, beneficiaries of those incentives and other goodies that have been written into the tax code over the years...all have either financial interests or positions of power to protect.

3. A flat tax is different. That means it has to be carefully explained. See below. Do you have the patience to read and understand the concept? Most don't. Sorry. Truth.

Here goes...

All income would be taxed and the definition of income would be broad and all encompassing - wages, tips, capital gains, bonuses, however it is that hedge fund managers get paid...whatever results in money in your pocket that wasn't there before. All gets reported. All gets taxed.

Now please, be patient with me. I'm going to make some assumptions and quote some statistics. Don't jump on me. For instance, I'm going to set the flat tax rate at 10%. It would probably be lower but I use 10% because that makes it easy to do the math in this sort of demonstration. I'm also going to set the poverty rate for an American family of four at $25,000. The feds actually set it a bit lower for 2014 but again, for the sake of the math...

We begin by deciding on the exclusion, that portion of income that is yours to keep in its entirety, that's not taxed. Think of it as the standard deduction in the current tax system. And let's say that we set the exclusion at 200% of the federal poverty level. Therefore, a family of four with a total income of anything up to $50,000 (twice the federal poverty rate of $25,000 for that family) will pay no taxes. Zilch. Two wage earners making $12 an hour each working full time, earning something over $40,000 total, will pay no income tax. As a percentage of total income, the effective tax rate: 0%

Now let's assume that the Mom and Dad in that family of four are social workers with a bit of seniority. They could be earning $50,000 each, making the family income $100,000. Exclude $50,000. That leaves $50,000 taxable. At 10%, the tax bill would be $5,000. As a percentage of total income, the effective tax rate: 5% (5,000/100,000 = 0.05).

Dad is an executive vice-president of a profitable local company earning a salary of $200,000. Mom is one of those $50,000 social workers, making the total family income $250,000. Exclude $50,000. That leaves $200,000 taxable. At 10%, the tax bill would be $20,000. As a percentage of total income, the effective tax rate: 8% (20,000/250,000 = 0.08).

A hedge fund manager makes $2,000,000 in 2014. Don't ask me how. His wife makes martinis. (OK. I'm a sexist pig. Roll with it.) His kids make Ecstasy in the pool house. Exclude $50,000, leaving a taxable income of $1,950,000. A 10% tax bill comes to $195,000. As a percentage of total income, the effective tax rate: 9.75% (195,000/2,000,000 = 0.0975).

Do you get the picture? It is indeed a progressive tax even though it's called a flat tax. The higher the income, the higher the taxes paid in both dollars and as a percentage of total income. Strictly limit deductions and other adjustments to taxable income. Move the exclusion as the poverty rate moves. Move the tax rate as necessary to cover the cost of government. Get rid of billions of dollars worth of tax preparation costs to the consumer annually. Slash the budget of the IRS. Figure your taxes on a postcard. What's not to like? If you understand the concept, what are the arguments against a flat tax? That it's too simple? That it's not progressive enough? What...?

Currently, about half of federal revenue comes from individual income taxes. About 10% comes from businesses taxes - down from close to 50% about 60 years ago. Lobbying pays dividends. This points out a major problem with a flat tax scenario. How do you apply a like, simplified structure to the self-employed, small businesses, and corporations? A topic for another day...




3 comments:

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  2. You nailed it...the IRS, H&R Block, Accountants, Congress, etc won't allow it...they would all have to get real jobs...they are parasitic jobs...then again your 1st point described me ... "1. Folks at the edges of both political parties have championed a flat tax."

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