This is my second diary for this project. From this point on, I will simply use the tag "Project Omaha". My thanks to Angie in WA State for that suggestion.
The title might make some Kossacks wince, but I'm perfectly serious. When we make it truly "Our" tax it will be a formidable weapon for fiscal sanity. Find out why I believe so beneath the fold.
In this project I will not spend much time arguing for progressivity in our income tax; that would be preaching to the choir. Kossacks might argue about how progressive it should be, but not whether. The federal income tax is a progressive tax, and that's a good thing. But it's too complex, and the rich have found ways to accommodate themselves to its intricacies.
Have you ever wondered why it is labyrinthine in its complexity? Don't you find it strange that payroll taxes, which are designed to tax the poor and middle classes, are starkly simple, while the income tax, designed to preferentially tax the rich, is stupefyingly complex? Do you get the impression that the loopholes were designed with your welfare in mind? How many middle class folks can hire an expert to structure their financial affairs to best take advantage of the complexity? Are you so naive as to believe the tax code was designed to insure fairness for all?
Enough of the rhetorical questions: you already know the answers. If you have half a brain, you know that you're being had. If the rich were being hurt by the complexity, you can bet that the income tax would be as simple as the payroll tax. They aren't, and it isn't.
Let's consider two concrete examples. First, consider a middle class family of four filing jointly with a gross income of $65,000. They own a modest home with a mortgage of $135,000 on which the pay annual interest of $9,000. Since they always have the option of taking the standard deduction of $11,600, the mortgage interest deduction is meaningless unless their total deductions exceed $11,600. But even if they have lots of other deductions, the most that the mortgage interest deduction can save them is 15% (their marginal rate) of $9,000, or $1350, roughly 2% of their gross income.
Now consider a wealthy family of four filing jointly with a gross income of $650,000. They own a very nice home with a mortgage of $1,350,000 on which the pay annual interest of $90,000. Even if they have no other deductions whatever, The mortgage interest deduction saves them $27,440, or about 4.2% of their gross income. Be assured, gentle reader, that they have plenty of other deductions.
The comparison is this: the middle class family gets a tax benefit ranging from 0% of gross income (when their total deductions are less than $11,600) up to a maximum of 2.08% of gross income. The rich family gets a tax benefit of at least 4.22% of gross income (when they have no other itemized deductions) up to 4.85% of gross income. With a single deduction, the progressivity has been seriously eroded.
The net result is that the mortgage interest deduction causes the middle class to carry a larger part of the burden than they would without it. If we did away with this deduction, and scaled down tax rates to make the transaction revenue neutral, the middle class taxpayer would see a tax reduction, and the rich taxpayer would see a tax increase. It is ironic that the standard deduction and the mortgage interest deduction, while ostensibly there to provide us with a measure of tax relief, both actually raise our share of the burden.
A deduction is only as valuable as your marginal tax rate. A deduction that saves the taxpayer 15% is not as valuable as a deduction that saves 35%. This means that the poor and middle classes are disadvantaged by all tax deductions. Deductions always favor the rich. Whatever advantage the poor and middle class get is always less than the benefit the rich get. And since we intend to make the tax code more progressive than it is now, this effect would be magnified. Income tax deductions are not our friend.
It would therefore be in our interest to have an income tax code with no deductions at all. If this seems radical, reflect that the principle works perfectly well for payroll taxes. Payroll taxes are models of efficiency, but not fairness. (We'll have more to say about payroll taxes in a later diary; I don't expect it to be controversial.)
There is one topic that a sane tax policy must address: capital formation. It would be foolish to tax the rich so heavily that there is not enough capital to invest in growth. That would be equivalent to eating the seed corn. On the other hand, a tax policy that enables the rich to get richer at the expense of everybody else is equally foolish. We don't need more seed corn than we can plant.
So I would propose that some percentage of household income be permitted to be sheltered from immediate taxation, much like we do for today's IRA. How much? We could start with 50% and adjust upward or downward, depending on whether we were raising enough capital to sustain growth. If the wealthy class were still getting wealthier, we should raise the upper marginal rates. We should aim for an equilibrium in which all income groups have the same relative chance for prosperity. There are those on the right who would call this class warfare. I call it equal opportunity.
It could work like this: Net contributions a qualified investment account (QIA) would be tax exempt. Net withdrawals would be taxed as income. The only securities that a QIA could hold would be securities issued by corporations involved in producing goods and services, or bonds issued by governments, or cash. Also permitted would be mutual funds or closed end funds holding only these securities. Investments not permitted would include derivatives, options, commodities, royalty trusts, hedge funds, short sales and the like. These would be legal in a taxable investment account (TIA) but not in a QIA.
Income would be everything that comes in, wages, tips, bonuses, stock options exercised, dividends, capital gains, country club memberships, company cars, whatever the employer provides that has monetary value.
I suggest we use income deciles, as the boundaries for ten marginal rates. The rate for each decile would be determined by revenue needs. Does anybody here have a simple way to get a ballpark estimate of total federal revenue given the rates for each decile?
We should get rid of this monster forever. Define income, publish the tax tables, and walk away. We should somehow forbid Congress to tinker with it; Congress is not good at tinkering. No deductions of any kind. IRS would still have some regulations, for example to define the monetary value of a company car. They would still have a few forms, but very few. For most people, filing a tax return would a 15 minute task. There would be no reason to scour the tax code for obscure deductions; they wouldn't exist.
Assuming that corporations would not be taxed (a discussion for a future diary, and perhaps a contentious one), the rewards for scrapping the tax code would be impressive indeed. Experts estimate that anywhere from 2 to 5% of GDP is wasted on nonproductive tax activity. In technical terms, we are pissing away half a trillion dollars a year, give or take a couple hundred billion. A few hundred billion here, a few hundred billion there—pretty soon you're talking real money.
I realize that there are undoubtedly many more income tax topics to be considered. For example, why do we have options such as filing individually, filing separately and head of household? Do these serve a purpose, or are they just an added complication to serve the purposes of the rich? (Frankly, I am ignorant, but I have my suspicions.) Is there a compelling argument for retaining the charitable donation deduction? I don't think so, but this could be a lively discussion, and I could easily be persuaded otherwise.
What I hope to accomplish with this diary is to define our vision for the ideal income tax. I know that what I have argued above is just a start. I don't have all the right answers; neither do you. But perhaps between us--who knows?
In the comments to “An Ex-Republican Tries to Make Amends”, a Kossack and I have had an extended disagreement on the wisdom of certain excise taxes frequently referred to as sin taxes. Please take a moment to weigh in on this issue. You might want to give this short Wiki article a glance. I advocate dropping all of them because they are regressive. I will (perhaps with slight reluctance) adopt and endorse the majority view in the Omaha project. Keep in mind that all Federal excise taxes only raise 2% of federal revenue, so the question is mainly one of principle. (I have omitted exise taxes that I feel are non-controversial.)