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