Sunday, April 21, 2013

Tax Reform

I think most people can agree that the United States Federal Tax Code is too complex. I'm becoming a fan of the Flat Tax even while I'm still a supporter of the Fair Tax.

The Flat Tax doesn't require the repeal of the 16th Amendment, so it would be an amazing step in the right direction toward the implementation of the Fair Tax. To be done correctly, it would still require the elimination of all other forms of Federal taxation:
  • Payroll Tax
  • Corporate Tax
  • Social Security Tax
  • Medicare Tax
  • Estate Tax
  • Capital Gains Tax
  • Dividend Tax
  • (probably others -- my ignorance of taxation doesn't mean I support it)
Elimination of most of these taxes would also eliminate the vast majority of Corporate loopholes in the tax code now.  That's an excellent outcome, because right now the Federal Government exerts too much control on which companies are favored and which ones aren't.  

The next step would be to eliminate all tax exempt loopholes and deductions as well.  To accomplish this, the following rules might work:

  • All perks must be made available to all employees at the same price (even those with no scheduled hours, or who are contract)
  • All perks must be optional, where the employee keeps the value of the perk as salary
  • That salary, whether it is used for a perk or not is taxable like all salary
  • The salary used for the perk is still taxable at the flat rate
This would be simple, only 3 rules, and would introduce market forces into the provision of perks.  Let's take the example of driving a company car for personal use.  Companies would be very cautious about letting just anyone have those vehicles, especially if they have branding on the exterior.  The company wouldn't want to be in the business of leasing vehicles to people, so the prices would naturally be raised.  The Government should not be involved in setting the value of those perks. 

Another example would be health insurance.  Actually, this example is probably the part that makes the whole idea worth while.  One of the problems with health insurance is that it is too frequently tied to employment.  People are not responsible for selecting, paying for, and maintaining their own health insurance coverage.  This rule change would eliminate the incentives for companies to hide the costs of health insurance from their employees.  Employees could accept group coverage if it was financially responsible to do so, and there wouldn't be a discussion of whether full time or part time people were offered the coverage.  It would all be offered at a price.  That price wouldn't impact income tax, and that price wouldn't be different for different people. 

The net change with all of this is that many people's reported income would rise.  One thing that may have not been obvious in all of this is that there is now no such thing as non-taxable income.  If you choose to invest your taxed income into stocks, bonds, gold, whatever, you've already paid your taxes, the rest is now yours to manage.  In the end, all of this may actually be an argument why the Fair Tax would be preferable in many people's minds.  Consider this:

Flat Tax

I earn $100,000 (theoretical round numbers)
The flat tax is 20%
I pay $20,000 in taxes on this income
I only need $50,000 to live on, so I invest the other $30,000
That eventually grows to $60,000, so I spend it on whatever I want, and the Federal Government doesn't get any more.
Total taxes: $20,000
Total stuff: $110,000

Fair Tax

I earn $100,000
I pay no taxes yet
I buy about $50,000 worth of stuff, and pay another $10,000 in sales taxes
I have $40,000 left to invest
That eventually grows to $80,000 (assuming an arbitrary doubling of investment over a somewhat long period)
Now I spend that $80,000 on stuff (here's where the timing of taxing gets a little tricky)
OK, so I theoretically get about $66,666 dollars of stuff, while paying about $13,333 in taxes.
Total taxes: $23,333
Total stuff: $116,666

Now of course, I made a bunch of assumptions in all of that, and it's possible that the Fair Tax taxation rate wouldn't be the same as a Flat Tax rate.  I used 20% for both.  I also calculated the Fair Tax as an exclusive tax instead of the inclusive rate which is proposed by the plan. I also ignored the effects of the prebate upon the whole scenario.  I think a bunch of the increase in the Fair Tax nominal rate is the expense of the prebate. The principle that remains the same in both examples is that there is no double taxation.  Taxing people again because they were frugal and invested their money is morally wrong, and it also sacrifices our country's future wealth for consumption today.  Both plans reward investment by eliminating double taxation, which will be an amazing improvement in our country's future.

In summary, I think both the Fair Tax, and the Flat Tax would be excellent plans to shoot for, with the Flat Tax seemingly slightly more achievable in the short term.  It would be nice if we could even dream about returning to an apportioned tax, where the States were responsible for all tax collection, and full competition in taxation strategies could create even more freedom, but for now, I think the Flat Tax would be a huge amount of progress from where we are now, and we could fight to move to the Fair Tax if we ever got there.

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