Monday, August 6, 2012

Fixing Our Shambolic Tax Code

The United States tax code is in complete shambles. 
It’s incredibly complex, and this complexity is driven by a myriad of loopholes and subsidies that also make it wildly inequitable. 
Why should Bob get to deduct his mortgage interest but Larry cannot deduct his rent payments? 
Why should the Duggar’s get tax benefits for the 283 kids they chose to produce, while their infertile neighbors could never take advantage of those same benefits?
They shouldn’t. 
The best tax reform is as obvious as it is simple – add up all your income and multiply it by a tax rate.  That’s it.  All income is treated the same, no credits, no deductions (except charitable giving), no allowances, no 100-page tax returns, no extensions, no H&R Block consultants, no boxes of receipts.  Simply determine your gross income from all sources (wages, interest, dividends, realized cap gains, etc.), find that amount on the IRS tax table and pay the amount shown.  The tax tables would be set with progressive tax rates, for example:
First $25,000 (or wherever the poverty line sits at any given point in time) taxed at 5%
$25,000 - $50,000 – 10%
$50,000 - $200,000 – 15%
$200,000 - $1,000,000 – 20%
$1,000,000 and above – 25%
The income bands and tax rates should be initially determined to raise revenue equal to a set percentage of GDP (e.g. 20%), and adjusted every few years to ensure tax revenues keep pace with GDP growth.  This will restrain the normal activities of government to a set percentage of our economy.  To the extent extraordinary expenditures are required, this amount can either be raised through debt, with the requirement that the debts be repaid with future tax receipts (i.e. at the expense of other programs), or raised through one-off duties or levies.  For example, if Iran somehow provoked another expensive war, any defense spending above and beyond the normal budgeted amounts would be considered extraordinary and would require additional levies – i.e. every citizen owes $500 in addition to their normal tax bill to fund the war.
Will this ever happen?  Not in the foreseeable future. 
The politics of taxes is poisoned with the pill of over-exaggeration and an unrelenting obsession with comparing thoughtful and pragmatic reform proposals with today’s broken and irrational tax code.  Politicians and their media shills take a small sliver of information and overstate its relevance with the intention of pooh-poohing the entire reform proposal.  Substance and thoughtful analysis be damned.    
For instance, instead of pointing out the inescapable progressivity of our reform proposal - opponents would immediately jump to some study that shows it will result in a tax increase on the poor and middle class.  It might even be proven to lower taxes for the wealthy (doubtful). 
Could this be true? 
Perhaps, and that’s not necessarily a bad thing. 
A worker making $25,000 a year will go from an effective tax rate (including payroll taxes) of perhaps 2.5%, to a new rate of 5%.  Headlines will read, “Tax reform double taxes on the poor”! 
Ignoring the political optics of that headline, is it really so terrible to have everyone pay at least 5% in income taxes?  At that level of income, it’s likely that any tax burden is offset by various federal assistance programs (i.e. food, energy, etc – which would be separately recognized as expenditures in the federal budget), but the psychology of seeing a deduction to your paycheck, or an amount due on your 1040, reinforces the individuals roll in our democracy.  Everyone has skin in the game. 
Perhaps even more troublesome would be the headline reading, “Proposed reform cuts taxes for the rich”.  It’s entirely possible that there is an individual making $5 million a year with an effective tax rate of 30% - and under the reforms, their tax rate could come down to 25%.  Instead of noting that this person will have an effective tax rate 500% higher than someone in the lowest bracket (i.e. 25% vs. 5%), and will pay almost 100,000% more in actual tax dollars to the IRS ($1,200,000 vs. $1,250), they will obsess about the fact that their overall effective tax rate will be reduced (i.e. the “tax reform will benefit the rich as the expense of the poor”). 
And herein lies the problem with any substantive reform effort.  
Why do we insist on comparing the projected results of thoughtful and robust reform proposals with the results of a system that everyone knows is in shambles?   It’s senseless and it’s destructive.
Until we can have honest and thoughtful public debates on important reform proposals (e.g. taxes, social security, health care, etc.), we’ll continue to reap what we sow.  Incompetent and irrational public policy will continue to result in a bloated government, wasted resources and a faltering economy.    


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