Taxes

Let's start with the basic issue of all government: money. If the government has no money, it cannot do anything. If it takes too much money, it doesn’t last long.

No one likes the current tax code except for the ranks of tax lawyers, accountants, and financial managers who make a living off interpreting it for the benefit of their companies or clients. For the rest of us, it is a nightmare. For decades, the government has used the tax code as a vehicle for providing incentives for particular activities. This has led to a lot of trouble. Remember the quote from The Federalist, that it would be counter-productive if the laws were to "undergo such incessant changes that no man, knowing what the law is today, can guess what it will be tomorrow."

The tax code is like that. Individuals and companies will structure their investments and their business around the current set of laws, only to have the laws change and suddenly everything you set up is no longer valid. This exact situation was one of the primary causes of the many Savings and Loan failures of the late 1980s. A tax incentive offered during the decade made it desirable to build office buildings, so many S&Ls loaned money to many groups to build them. Not only did they build too many, which made most of them unprofitable, a change in the tax laws removed the tax advantages that many companies had planned around. Thus, the builders could not repay their loans, and the S&Ls ended up eating a lot of debt.

Another problem with the tax code is that it is full of lobbyist loopholes, providing tax incentives or relief for various companies, industries, or activities. The tax code is the number-one feeding ground of lobbying groups, all of whom are trying to get some advantage for themselves. Lots of the corruption that dirties our government is caused by lobbying for tax relief or special tax status.

Another complaint about the current system of taxation is that it is unfair. It unfairly places the burden upon one segment of society, to the detriment of the others. Of course, the burdened segment of society depends largely upon which segment you are in. The wealthy think that the graduated tax percentage scale unduly burdens them. The poor think that the wealthy don't pay enough. And the middle-income citizens see themselves being squeezed by both top and bottom.

Most of these problems go away with a no-itemization flat tax. This is a simple tax code, it treats everyone precisely the same. It eliminates all loopholes and special-interest incentives.

So, here is the simple tax plan...

The Simple Tax Plan

Step One: Abolish the Corporate Tax Entirely

That's right, abolish the corporate tax. Why? Because it's good for America. After all, who pays that tax? When a corporation has to pay a tax, it can only get the money to do so through one of four means:

  1. Raising Prices, which means that the consumer pays.
  2. Lowering Salaries, which means that the employee pays.
  3. Hiring Fewer Workers, which means that society pays (since unemployed workers will generally take money from the government in terms of unemployment, welfare, etc).
  4. Lowering Dividends to Stockholders, which means that the stockholders pay.
Given that the primary stockholders of the corporation are the people making the decision as to which of these four options to choose, it's an easy guess which of them will be least likely. Also, people who invest in a company deserve to make something for their investment. If the company cannot continue to pay dividends to stockholders, the company stock will fall, possibly to the point that the company goes out of business, which isn’t good for anyone.

Another reason to abolish the corporate tax? It makes America more competitive on the world market. Goods produced in America would be cheaper and better able to compete with foreign competition if US companies were not taxed at home. Many foreign governments do not tax their corporations, particularly those third-world nations whose products are constantly underselling our own. If we that better able to compete against such companies, that means more jobs for Americans. It also makes it less desirable to move a company to another country, which keeps more jobs here in America.

Abolishing the corporate tax will lower the price of goods. Not only do the corporations no longer have to pay tax, they can also eliminate an entire group of high-cost employees whose sole function is to interpret the tax code and structure the company so that it takes advantage of those laws. (In extreme cases, this is known as 'cooking the books.') It means that the company is free to build their business instead of constructing tax shelters.

Finally, abolishing the corporate tax will remove the single biggest incentive for corporate corruption.

Step Two: Establish a No-Itemization Flat Tax

Here is how the No-Itemization Flat Tax works.

  1. You count your income.
  2. You subtract a standard deduction based on the size of your family.
  3. You send 25% of the remainder to the government.

The plan would include large standard deductions for family members, in order to reduce the tax burden on the poor.

As with all tax systems, the big question is always "What counts as income?" In this plan the answer is, everything. All wages, salaries, tips, dividends, investment income and capital gains count as income. (Obviously, for investments and capital gains, you only pay tax on the difference between the purchase and the sales price at the time that you sell the asset.)

The next big question is, "What can I deduct?" In this plan the answer is, nothing. The only deduction is the standard deduction for family size. There is no deduction for home loan interest, medical expenses, or any other thing. No earned income credits. No pre-tax investment strategies. No alternative minimum tax. I'll address other ways to deal with some of the more common deductions that people might miss later in this document, but the answer is, nothing is deductable. After all, each of these deductions was put into the tax code at some point to provide incentive for certain activities or relief for others. Once in, they are painfully hard to root out. And all they do is add to the general lack of understanding and trust in the code. Why muck up the tax code with such junk?

When we need to raise or lower revenue, what do we do? Very little. We don't change the tax percentage at all. It remains at 25% forever. What we change is the size of the standard deductions for family size. I would even go so far as to have it go up or down automatically, based on the previous year's budget deficit or surplus. I'll talk about that later, too.

Here are some examples of how this would impact people at certain income levels. To see how this would impact you, pull out your most recent tax forms, look for the line that lists your total income from all sources. Then subtract the standard deduction for your family and multiply the result by 0.25. For this example, I am using a standard deduction of $10,000 per adult and $5000 per child. These numbers may not be the actual deductions, but should be close.

INCOME ADULTS KIDS DEDUCTION TAXABLE INCOME TOTAL TAX REMAINING PCT PAID
10,000 1 - 10,000 - - 10,000 0.00%
10,000 2 - 20,000 - - 10,000 0.00%
10,000 2 1 25,000 - - 10,000 0.00%
10,000 2 2 30,000 - - 10,000 0.00%
20,000 1 - 10,000 10,000 2,500 17,500 12.50%
20,000 2 - 20,000 - - 20,000 0.00%
20,000 2 1 25,000 - - 20,000 0.00%
20,000 2 2 30,000 - - 20,000 0.00%
30,000 1 - 10,000 20,000 5,000 25,000 16.67%
30,000 2 - 20,000 10,000 2,500 27,500 8.33%
30,000 2 1 25,000 5,000 1,250 28,750 4.17%
30,000 2 2 30,000 - - 30,000 0.00%
50,000 1 - 10,000 40,000 10,000 40,000 20.00%
50,000 2 - 20,000 30,000 7,500 42,500 15.00%
50,000 2 1 25,000 25,000 6,250 43,750 12.50%
50,000 2 2 30,000 20,000 5,000 45,000 10.00%
100,000 1 - 10,000 90,000 22,500 77,500 22.50%
100,000 2 - 20,000 80,000 20,000 80,000 20.00%
100,000 2 1 25,000 75,000 18,750 81,250 18.75%
100,000 2 2 30,000 70,000 17,500 82,500 17.50%
1,000,000 1 - 10,000 990,000 247,500 752,500 24.75%
1,000,000 2 - 20,000 980,000 245,000 755,000 24.50%
1,000,000 2 1 25,000 975,000 243,750 756,250 24.38%
1,000,000 2 2 30,000 970,000 242,500 757,500 24.25%

In this plan, the wealthy don’t get to deduct any more than the poor. Today, the wealthy pay a higher percentage of tax, but they also have a lot of ways to protect that money from the IRS. This plan lowers their overall tax rate, but gives them fewer methods of hiding their money from the tax man. Given that this is a simple calculation, it should be fairly easy for the Government Accounting Office to determine the levels at which to set the standard deductions in order to achieve the desired revenue.

Who loses in this plan? Tax attorneys, certified public accountants, and financial managers: anyone whose sole business is built upon helping people count, invest, re-structure, hide, and protect money from the tax man. These are people that only the wealthy can afford to hire. Other losers are tax preparation companies and the makers of tax preparation software. It is to be hoped that a robust American economy fueled by the removal of the corporate tax would create jobs for these people, and for the hundreds of IRS auditors who would find their jobs unnecessary.

Step Three: Use Other Programs for Incentives

If you still want to promote certain activities that are currently promoted through tax incentives, simply create new programs to handle these things. For example, if you want to give first-time home buyers a break on their interest payments, set up a program through the Housing department whereby banks could offer low-interest loans to buyers, with the difference paid by the government. If you want to promote the sale of hybrid cars, establish a program to have a portion of the sale price charged to the government through the Department of Commerce. My point is that there are other, better ways to provide incentives than by complicating the tax code.

Step Four: Let the Deductions Float

Every year, the size of the standard deductions should float up or down in order to keep revenue equal to expenditures. Many of us have an equal payment plan on some of our utilities. For those who don’t here is how they work, using your power company as an example. After a year of service, the power company will determine what your average monthly usage was. Instead of charging you for your usage each month (which would cause your monthly payment to go up and down as power usage changed season to season), the company charges you for the average monthly usage from the previous year. At the end of each year, your monthly payment is re-assessed based on the new usage. If you are using less than the norm, then you will have a credit on your account, and your monthly payment will go down enough to both meet the new norm AND remove the credit. If you used more than the norm, your account will have a deficit and your monthly payment will go up enough to both cover the new norm and pay off the deficit.

In the same way, the tax plan would allow the deductions to float. If the government has a deficit in one year, the standard deductions would go down, increasing revenue enough to both balance the budget and pay off the previous year’s debt. If the government had a surplus, the standard deductions would go up, leaving more money in the hands of the citizens, to the point that the budget is balanced AND last year’s surplus returned to the people.

Please see my plan for the balanced budget to see how this tax plan fits into an overall strategy of a fiscally responsible government.

Investments

One question about this plan revolves around investments, particularly retirement investments popular today (401Ks, IRAs, Roth IRAs, etc). Another question arises around educational investments that currently carry tax incentives. All of these could be replaced with two or three investment options.

Employer-Contributed Retirement Plans: In this plan, your employer would put money into a retirement plan on your behalf. This is a benefit provided by your employer, replacing the current selection of profit-sharing, pension, and employer-funded 401K plans. Since the money is not salary for you, it is not taxed going in. If you take the money out before reaching retirement age, all money is subject to tax, and would add to your income for the year. After reaching retirement age, only the employer-contributed portion is taxed, not any investment income. You do not begin paying tax until the amount remaining in the account is less than the total of all employer contributions. Employer contributions can be of any size, but must be proportional across all employees (for example, 15% of the salary).

Self-Contributed Retirement Plans: In this plan, you put money aside for your own retirement. Since all of your income is taxed, this is done with post-tax dollars. If you take the money out before reaching retirement age, any investment income is subject to taxation and would add to your taxable income for the year. After reaching retirement age, you can take money from this account freely with no tax at all. There would be some limit to how much can be put into such an account, otherwise this becomes much too profitable an investment, a certain way to avoid investment income and capital gains taxes.

Education Plans: These would operate just like the Self-Contributed Retirement Plans, except that the investments must always be in the name of a minor with an adult as custodian. Money is put into the plan post-tax. Money taken out of the plan for educational use would be non-taxed. (Colleges and universities would be encouraged to create student credit accounts that could only be used for legitimate educational expenses. Educational plans would make cash transfers directly into those accounts on behalf of the students.) If there is any money left in the account when the student is done, the remainder can be withdrawn by the custodian or transferred into a retirement plan for the student. Any amount beyond the initial investments would be taxable if the custodian were to remove it.

Other Sources of Revenue

Note that all of the above applies only to the corporate tax and the income tax. Other types of taxation are still available and advised. Some taxes are applied in order to control behavior that is detrimental to the user or society (such as a tax on tobacco or alcohol), some taxes are applied for a specific purpose (such as a gas tax to raise revenue for highway construction). Nothing outlined above prevents these sorts of specific taxes from being applied in order to achieve some of the same results that are currently found through the complication of the tax code.

Why is This Better?

  1. It is easy to understand.
  2. It is applied equally to all taxpayers.
  3. It eliminates corporate taxes, which makes corporations more competitive.
  4. It eliminates loopholes that only apply to the wealthy.
  5. It eliminates possibilities for corruption.
  6. When taxes go up or down, they go up or down the same for everyone.

What About a National Sales Tax?

There are a couple of proposals out there for a national sales tax to take the place of the current tax code. One of the most popular is called The Fair Tax. It has some good points, such as eliminating the corporate tax, but it does not solve the fundamental problem of inequity. National sales taxes will push the tax burden down and drop it on the backs of the poor and middle class. Those making enough money that they don’t have to spend it all will be able to invest it instead of spending it, which makes it possible to avoid all taxes on a large portion of your money. The theory of a national sales tax is that the more you earn, the more you spend. And this is true, up to a point. At some point, though, the more you earn becomes the more you can afford NOT to spend. Since putting money into an investment is not a taxable event, the richer you are, the lower a percentage of your income needs to be paid in tax. These plans also usually contain provisions for lower-income people to either not pay tax, get their taxes back at the end of the year, or be paid a stipend to offset the tax. In those plans, the tax burden falls primarily on the middle-income family.

Some people will argue that investment is good for the economy and therefore allowing the wealthy to invest tax-free is a great stimulus that is good for everyone. The people who make this argument are all wealthy. While it may be true that investment stimulates the economy, the primary beneficiaries of this stimulation will still be the investors, not the workers.