Wednesday, February 25, 2004

Fair Taxes and Improved Economy

Here's a simple solution that will finally make income taxes fair and simple and, at the same time, will fix our economy.

  1. Eliminate income tax on business. Tax only individual people. Business owners should be taxed ONLY on the money they take out of the business as personal income.

  2. Tax individual people at a flat tax rate of 25% of the income above their first $40,000 per year. No loopholes. No deductions. No progressive rates. No subsidies for any "special" groups like home owners or married couples or people with children.

  3. All money coming in to the individual should be taxed including wages, interest, dividends, capital gains, inheritance and gifts etc.
There are two variables here the government can play with: the flat percentage rate and the baseline amount (25% and $40,000 in number 2 above). There should be a constitutional amendment declaring that federal income taxes must follow this structure and that these two variables are the only aspects of this structure that congress gets to modify and play with. That same constitutional amendment could declare that sales taxes are illegal, forcing all states to eliminate sales taxes and hopefully follow the example of the fair, simple federal income tax. If the federal government as well as the state governments followed this guideline, taxes would be fair and our economy would take off like a rocket.

Some details: In the case of estate taxes and any income derived from the death of a person, the baseline amount should be set at a million dollars. To calculate withholding, any predictable payments such as regular salaries should calculate the appropriate withholding based on the annualized income. Any unpredictable payment such as website commissions should be subject to a withholding of half of the flat percentage rate. Naturally there are a lot of details that are not addressed here but this principle of simple, fair income taxes on individuals only is sound and will lead to better compliance and a more prosperous economy.

This approach is fair to everyone because everyone, rich and poor alike, is taxed by the exact same formula. The baseline amount protects low-income people. There is less incentive to cheat because the system is fair to everyone equally.

What about a capital gain on the sale of your home? The capital gain is the sales price minus the purchase price and that is what should be taxed. Keep it simple - interest rates and payments should not factor into the equation. This rule should apply to anything an individual sells at a gain such as a car or a boat or artwork (few individuals own anything that gains value other than a house). These rules are exceedingly fair, simple and consistent. There are NO special rules for houses versus artwork and there are NO mathematical gymnastics to deal with changing interest rates. Just fair and simple.

What if your home loses value? Too bad. There are no deductions for capital losses because there are no deductions.

Why not tax business? Because "business" is just a concept. Without people, there is no business. People are the atomic level entity making and spending money. In addition, taxing business is complicated. Some businesses like grocery stores have very low margins whereas other businesses have margins over 30%. It's these differences in margin that make it necessary to tax based on "net" income and that's what introduces all the complexity and unfairness in the income tax system. The concept of taxing "net" income opened the door to special subsidies for home owners and other such nonsense that simply isn't equally fair to all parties.

This flat individual-only income tax will improve our economy because businesses will be able to focus soley on good business rather than red tape and tax impact. Will the absence of income tax from businesses significantly reduce federal tax receipts? Not much. It's a little-known fact but individual tax payers provide the bulk of federal tax receipts. Businesses don't really pay much into the government anyway, but they do spend a lot of resources managing their income tax liability.

The budget of the IRS is somewhere in the neighborhood of $10 Billion (with a B) per year! That's an instant nearly $10 Billion dollar savings if we can reduce the vast IRS beauracracy.

Some people advocate a national sales tax to replace the income tax system. That's a pretty ridiculous idea. There is already a pretty good incentive to cheat on sales tax by purchasing online or out of state. How much more incentive would there be if the sales tax was high enough to replace the income tax system? On top of that, sales tax receipts by the government would fluctuate wildly with the economy and therefore, predicting receipts and setting the budget would be a guessing game. Receipts from a flat income tax would be much more stable and would lead to a much healthier economy.

Some people argue for a national sales tax on the basis that government should tax consumption rather than production in order to encourage people to save but it is NOT the business of government to decide if people should spend or save their money. This is a common mistake but it's very important to remember that government exists in order to protect the rights of its citizens, not to influence the activities of its citizens. It is not government's job to be promoting family values or savings or sexual abstinence. With this principal in mind, it's easy to see that a flat income tax on individuals only and not on businesses is far superior to a national sales tax.

My prediction is that this flat individual-only income tax system would lead to the strongest economy the world has ever seen, even surpassing the dot-com bubble of recent years.

The day we have a fair, simple, transparent flat tax where everyone follows the exact same formula is the day that national debate on limited government will really begin.


At 8/12/2004 10:39:00 AM, Blogger Doctor Biobrain said...

Flat tax is a lousy idea. First off, the 25% over the first $10,000 is a HUGE tax increase for most people. For example, a single person with no kids who earns $30,000 would pay $5000 in taxes under your plan. Under the current system, that person pays $2954, according to the IRS's tax calculator. You will have screwed this person, and married folks and folks with kids would get even more screwed (not that you care about them).

And even at higher levels, you screw people. A single person with no kids who earns $50,000 would pay $10,000 under your plan. Under the current system, that person would pay $7256. Is that what you're really about? Making poor and middle-class folks pay more taxes?

Someone making $15,000 pays $1250 under your system, yet only pays $708 now. Someone making $80,000 currently pays $14,808, yet would pay $17,500 under your system. And these are all single, no kids, no deductions people who are paying the most already and are the ones you're trying to help.

But someone making $250,000 currently pays $68,046, but would only pay $60,000 under yours. Someone making $500,000 currently pays $154,210, but only $122,500 under your system. Of course, this assumes that they take the standard deduction, so it's quite possible that they'd end up paying just as much. But we're still screwing the poor and middle-class. Hell, a guy who makes $1,000,000 with $250,000 in deductions pays $252,409 under the current system, but only $247,500 under your plan. So even with high deductions, your plan saves him money.

And the fact is that it's very difficult to arrange a flat tax so that it DOESN'T benefit the very wealthy. You can alter the base amount or the rate, and it'll always benefit the very rich. That's why many wealthy people advocate it. And the more money they earn, the more they benefit.

And then there is the issue of taxing business owners for their personal income. Example: A handyman takes in $40,000 total revenue, but has $20,000 in expenses related to that. Normally, all of this goes on a Schedule C on his 1040 tax return. Are we going to tax the $40,000? No, because the guy didn't earn $40,000. That'd be like taxing an employee for the desk, phone, paper and other things an employee needs to do their job. So he'd have to figure out how much his expenses were, and we'd need an IRS to make sure he wasn't lying.

Example two: A business owner has a small corporation he owns alone and receives $1 million in revenue, but spends $990,000 making that money. In effect, his work has earned him $10,000. And those earnings are put on a Schedule K and taxed directly on his 1040 like any other income. And again, we need the IRS to tell him which business expenses are valid and to make sure he's not cheating. He took home $10,000 and even the flat tax needs a tax code to show that he only made $10,000, and doesn't tax him as if he made the full $1 mil.

Many businesses are lucky to run a 15% profit margin, and taxing the full amount would overtax business owners and often make them pay more in taxes than they earned. In this example, this businessman would have to pay $247,500 under your tax proposal if it was based on total revenue, so even if he had an extremely good profit margin of 20%, he'd pay more in taxes than he earned. Again, taxes would have to be paid on his net income, and we need rules and enforcement to make that happen.

And these are the guys that the IRS is really after, and why we have most of the tax code. Most businesses pay their taxes directly on the owner's 1040. And these aren't weird or unusual. It's the way most businesses are run. If you go to any no-name florist, liquor store, bar, restaurant, barbershop, shoe repair, or antique shop, most likely the owner is paying their taxes on the same tax form you use. They work at the store, but instead of getting a straight wage like you, their profit is their salary. And we need rules and enforcement to make sure they pay their fair-share, no matter WHICH income tax system we use. And I know all this because these people are my clients.

Does any of this mean anything to you? I can go on and on about this stuff. I'm a tax accountant, so I'm a little biased towards the current system, I guess. But spending lots of time working with this stuff, I can't really see anything much better. Most of the tax code doesn't even apply to you, and a simple program like Turbotax is all you'll need to make tax time easy and as painless as possible. Even the typical handyman can use Turbotax for fairly painless tax handling (and that's what I recommend to many who want to pay me to do it).

But I really suspect that most flat-taxers are really wanting lower taxes. But you can't get blood from a turnip, and the only way to reduce taxes is to reduce spending. But a majority of Americans like our high spending levels, and in our country the majority rules.

I'd be happy to explain this stuff further. I can give lots more reasons of why flat tax is bad policy, and they are all based on my personal knowledge of the tax system and real-world applications. And as a married man with three kids and a mortgage, I can give you even MORE reasons why I like the current system, though you will probably find those to be unfair.

At 8/14/2004 12:46:00 AM, Blogger David said...

Thank you for the feedback but unfortunately, all of your arguments are either wrong or simply miss the point entirely.

The reason for your vehement opposition to a flat tax became crystal clear the moment you mentioned you are a tax accountant. Obviously you need the system we have now or else you would be out of a job. That says it all but for the benefit of others reading this, I'll clarify your errors anyway.

Example of how you are clearly wrong:

You said it is very difficult to design a flat tax that doesn't benefit the wealthy. What if the the baseline amout was $100,000 and we only taxed income at 25% of the excess over $100,000? Obviously only the rich would be taxed. This simple example easily blows away your inane assertion. Your assertion is clearly nonsense.

In addition, have you ever heard of the AMT (alternative minimum tax)? The AMT is expressly designed to catch wealthy people who otherwise would have so many deductions they would pay little or no income tax. Duh! Get a clue mister. Rich people pay far less taxes than your phony examples because they buy houses and investments to the point their deductions nearly eliminate any taxes they would otherwise owe. If you want to claim it's not so then why is there an AMT and why do politicians always say the AMT is to prevent the wealthy from completely avoiding income tax?

My flat tax proposal completely eliminates the escape route for the wealthy and they would pay far more taxes under my plan than they do now AND it would be fair (we wouldn't simply be soaking the rich). Remember Leona Helmsley? She said, "we don't pay income tax, only the little people pay income tax".

Example of how you really missed the boat:

You complain that many people would "get screwed" and pay more taxes under my idea than what they currently pay. If that's the case, and the government gets more money from us than needed then we simply lower the tax percent or raise the baseline appropriately. Is that so difficult to understand? Have you heard of the concept of an "income neutral" flat tax? What that means is we design a fair, simple flat tax and set the rates so that the government continues to take in exactly the same amount of money as they currently do, no more, no less.

Example of how you missed the boat on ethics:

You said that homeowners and people with kids would get screwed even worse. Well, if you call increased fairness getting screwed, maybe. If you have kids and own a home, under the current system you will pay FAR less income taxes than someone making an identical salary without kids living in an apartment. Do you think that is fair? Does your idea of fair taxes simply boil down to "if I get to pay less than my neighbor it is good, otherwise it is not good"? Geez....

Example of how you missed the boat but only because I was unclear:

You talk about a business owner making 40K but having expenses of 20K. Thank you for bringing this to my attention. I need to clarfiy this point. The business owner is only taxed on the income he takes out of the business as personal income. Obviously, the business owner isn't going to deposit 40K into his personal checking account. He may not even deposit 20K because some of the profit may be left in the business to grow the business. But he has to know what he takes out of the business for his personal income and that is the part that is taxed. Detailed accounting is required right now on the part of the business owner and it can only get simpler under my proposal.

The ironic thing is, if we move to a fair simple flat tax, EVERYONE will have more money and pay less tax! Homeowners and apartment dwellers and people with kids and people without kids will ALL pay less tax. This is a simple result of the fact that a lot of effort is wasted, like friction, on the tax bureaucracy and without that friction the entire economy will run more efficiently and everybody will be better off.

You seem to be ethically challenged. You don't seem to grasp the difference between something being right or wrong versus it being beneficial to you or not. Just because something benefits you as a tax accountant home owner with kids doesn't make it right. If you want some help understanding important concepts like this I'll be happy to explain it all to you.

Thanks again for the feedback.

At 10/10/2006 09:38:00 AM, Anonymous Anonymous said...

I thought the author of this tax idea said the first $40,000 would be tax free - not $10,000

So if a person earns $30,000, they would not pay anything as that is less than $40,000.

Likewise, the person earning $50,000 would pay $2,500 ([50,000 - 40,000]x 25%) and not $7,256 as suggested here.


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