The US Tax System is Broken. It does not need tinkering. It needs
Radical Simplification. Radical Simplification itself is not be a partisan issue. Afterwards, we can debate the real partisan issues: tax revenue targets and tax rate progressivity.
To achieve both radical simplification and progressivity, it likely should be framed as a Grassroots Tax Revolt. As explained in the article linked here, Americans have throughout history embraced tax revolts.
All Federal taxes should be unified as a single Reformed Income Tax. Right and Left each get to claim victory: the Right gets rid of the burdensome Corporate Tax and the hated Gift and Estate Tax, the Left gets rid of onerous Employment Taxes and unfair Capital Gains tax breaks for the rich. All that is left is an individual Income Tax, with no distinction between income from labor or from capital, but with a deduction for all savings and investment.
A lot is packed into a small space above. I will try to unpack it here.
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NON-PARTISAN BASICS
Radical Simplification in and of itself should not be a partisan issue. It merely provides a framework to address the difficult issues (discussed further below): first, how much revenue does the tax system need to collect in order to fund a right-sized government; then, to achieve this revenue goal, how progressive, flat or regressive should the schedule of tax rates be?
What then does the Reformed Income Tax look like? It looks very similar to the current Income Tax, based on withholding taxes and an annual reconciling tax return, but it has two major differences. First, earned income and capital income are treated identically with no distinction in rate schedules, and therefore no need for the vast set of complex rules needed to determine whether a particular income item is a capital or ordinary. Second, all investments are fully and immediately deductible--in essence, treating all investments in the same way 401(k) plan investments are now. Unlike capital gains tax breaks, which provide an incentive for dis- investment, the Reformed Income Tax would actually encourage investment and savings by all Americans.
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TAX REVOLT FRAME
To achieve radical reform, both the Left and the Right need to be excited with the "cause" - hence the Tax Revolt frame. The Left's rhetoric should center around ending regressive Employment Taxes; the Right's around the steeply progressive Gift and Inheritance Taxes (or "death taxes" as they prefer).
Corporatists can also get into the act, calling for the end of the "anti-competive" and capricious corporate tax.
Finally, even Moderates can latch onto Simplification as a Tax Revolt goal in itself, bolstering support for the Left, Right and Corporate anti-tax positions.
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THE PARTISAN ISSUES
Even while advocating non-partisan Tax Revolt and Simplification in general and the Reformed Income Tax in particular, the Left needs to keep their eyes on the ball with respect to the true partisan issues. The tax system, simple or complex, is of course simply a framework to achieve: first, collection of adequate tax revenues to fund government programs; and, second, to allow equitable distribution of the resulting tax burden.
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Target Revenues
In theory, before enacting or extending any tax, legislators ought to consider what the revenues will be used for, and ought to estimate how much revenue they need to achieve their goals. With the current complex and capricious tax system, it is easy to understand why this step is often overlooked. If a legislator cannot estimate the effect that any tinkering may have on tax revenues, why bother approaching the intended uses with vigor? Even in pursuing Radical Simplification, it may prove difficult politically to address the revenue side of the equation as squarely as it should be. The Left needs, however, to be vigilant in fighting the Starve-the-Beasters on the Right by arguing that the Reformed Income Tax will need to fund a host of progressive causes. At the same time, we on the Left need to be prepared to fight the corporatists and the war profiteers by arguing that monies need to be shifted away from corporate welfare and the war machine in order to fund the proper priorities.
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Progressive Tax Rates
The second partisan issue is easier to bring to the debating table than the first. Having decided that we need a certain level of tax revenue, then it is time to consider what tax rate structure that can produce these revenues should be selected. The most important thing about Radical Simplification is that it clears away the smoke and confusion and makes it possible to address progressivity directly and honestly. Let the Right argue for a Flat Tax or even a Regressive Tax! Once the smoke clears, the public will agree that a progressive tax rate structure is appropriate. In order to be fair--even to the wealthy--and moreover encourage work and investment at all wealth levels, the top rate ought not to be confiscatory. Once the system is cleaned up and simplified, it should not be difficult to insure that a top combined Federal/State rate of, say, 50% is adequate. The Right won't like it, but they'll be able to live with it.
Even if the public were convinced that a flat rate at all income levels were appropriate, the result would be better than the current system which is an unhealthy mix of progressivism and regressivism. Currently, the Middle Class are typically taxed at the highest rate (especially those who rent their homes) because they are subject to both the Income Tax and the Employment Tax on their full incomes, while receiving little if any benefit from reduced capital gains rates. The Poor, in contrast, bear only the unlimited Employment Tax (currently mitigated somewhat by the Earned Income Credit), while the Rich do not have to pay Employment Taxes on their income in the six figures and are able to structure much of their income to qualify for lower Capital Gains rates.
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PUTTING ALL OTHER FEDERAL TAXES IN THE DUSTHEAP
Capital Gains distinction - By far the greatest complexity in the tax code comes from the intricate and arcane rules designed to prevent taxpayers from convert ordinary income into capital gain. These rules would be wholly obsolete after reform. Instead, all gross income received, whether from receiving a paycheck or from selling a share of stock, would be subject to taxation unless it is invested/re-invested or saved.
Corporate Income Tax -- The chief problem with corporate taxes are that their "incidence" is unclear--that is, unlike sales taxes (which are clearly borne by the consumer), economists cannot determine to what extent corporate taxes are borne by shareholders as opposed to employees or consumers. Radical simplification would eliminate corporate taxes. Further consideration is needed whether a basic corporate level tax should be maintained as a prepayment mechanism and a means of taxing foreign shareholders.
Social Security - There would no longer need to be explicit FICA/SSI taxes; just, unlimited progressive income taxes. Even if FICA and SSI were retained, the caps should be removed so as not to undo the progressivity of the system. In any event, fundamental tax reform would not change the social security benefit structure--just how its funded.
Gift and Estate Tax - The Right can have their "death tax" victory, but it would be pyrrhic because gifts and bequests will be treated as income and subjected to tax in the hands of the heirs unless they invest or save the funds received--and, even then will be taxed when the funds are disinvested.
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OTHER ISSUES / FUTURE POSTS
Transition Issues There are two sets of transition issues. The first is inherent in the shift to the Reformed Income Tax, namely how to provide credits for income that has already been taxed but was previously re-invested (or saved) under the current system. The second is more contentious and partisan: Should these transition credits be funded by a surcharge or other tax on wealth accumulated as a result of Bush's inequitable tax cuts?
State Taxes / Federalism Issues States can do what they want by are encouraged to drop the Property Tax (disliked by the Right) and Sales Tax (disliked by the Left) alike, and piggyback on new Federal Income Tax, applying same rules but allowed to select own incremental tax rates.
International Issues Treatment of foreign resident individuals who make direct and indirect investments in the United States remains a difficult issue. One solution would be to retain a partial Corporate Income Tax, scaled by the share of non-resident shareholding, but a variety of other approaches are possible.
Remaining Complexity It is clear that the Reformed Income Tax would simplify many aspects of the tax system, such as eliminating the need to track basis in assets or to distinguish capital from ordinary income. Unfortunately, there are a number of areas where complexity will unavoidably remain. In addition to the international issues discussed above, the difference between a true corporate business expense and a taxable benefit to an employee remains contentious. The cash economy continues to plague the system as well.
Credit Where Credit Is Due Credit needs to be given to thinkers and commentators like David Bradford and others who have created a vast wonkish literature on Consumption vs. Income Taxes.