If ever an intervention was called for, it would be to cure the addiction to the current tax code, before we tax ourselves to death.
Except for the afflicted, everyone seems to recognize that our government has a taxing problem. And this addiction not only wreaks a debilitating effect on government itself, it also weakens the fabric of society. If ever an intervention was called for, the current tax code is begging for one. Sure, a certain amount of social taxing is acceptable, but when taxing is seen as a libation that will solve all problems, then an egregious dependency becomes an incapacitating problem
Most folks understand the need for reform and temperance when it comes to taxing, but for politicians, the power to tax is so intaxicating that none are willing to step up to the bar to control it. As with other types of addictions, finding a cure may, at first, seem daunting, but the truth is that it’s not very taxing to find a better way of taxing.
The Power to Tax is the Power to Destroy
The fundamental reason governments grant themselves the power to tax is simple: To pay for the protections and services that are provided by government and demanded by the governed. While this basic premise is acceptable, it has led to a philosophical political dichotomy. One group believes in a minimalist government providing limited services, collecting minimal taxes and allowing individuals to “fend for themselves.” Another group veers to the opposite extreme. They believe by that the purpose of government is to “fend for everyone” and that all should pay their “fair share of taxes,” regardless of whether or not they want, need or use the services of government.
There is another philosophy that also violates the fundamental concept of taxes: The use of the power to tax to incent or reward specific individuals or groups to behave in certain ways. For example, allowing individuals to deduct interest payments on mortgage loans was designed to encourage home ownership and stimulate the housing sector; tax deductions for new equipment are intended to encourage businesses to expand. Taxes placed on liquor or tobacco – “sin taxes” – are designed to discourage drinking and smoking as well as raise needed revenue. Such use of the power to tax – or not tax – may have well-intended objectives, but they do not fulfill the basic reason for taxes and the outcome can – and does – lead to complexity, inequity and abuse.
The Tangled Morass of Tax Legislation
The current tax code had its genesis in 1939 when it consisted of 15 “tax sections” detailed in 504 pages. By 2010 the tax code had expanded to 9,840 “tax sections” with over 78,000 pages of details, explanations and exceptions. All of this detail and complexity and still the government cannot collect enough revenue to pay for its activities. Probably an even worse outcome than its complexity and shortfall in revenue is that the tax code is inequitable and favors the rich and powerful.
The current convoluted tax code is neither efficient nor effective, and most of all it is not fair since it allows – encourages — multi-millionaires to pay less in taxes – as a percentage of their income and sometimes even total taxes – than those who work for them. That may be totally legal, but it is certainly not equitable. Consider, for example, that companies like General Electric and Apple make billions in profits and pay zero in taxes, while other companies actually have their profits taxed twice. (Taxed first as corporate income and then again as dividends to shareholders.)
We could go on and on about the complexity, inefficiency and inequity inherent in the current tax code – not to mention the myriad abuses – but it is better to focus on a solution. The difficult challenge – and why so little progress is being made today – is not because the current system is so broken, but because the system is so fundamentally flawed that it cannot be fixed. In such a scenario the simplest and most effective approach would be to simply trash the current tax code and start all over with a new one.
Of course, this will never be done, because too many of the rich and powerful – individuals, corporations and politicians – are too addicted to and have too much at stake in benefiting from the current system. But if somehow intervention could be possible and those intaxicated by the current tax code would accept treatment, what would the cure entail?
(Note: The percentages and numbers used below are for example and not intended to be a specific recommendation.)
To start, there would be just a few “tax sections” in the new code:
The single most powerful cause of the current tax code’s complexity, confusion and inequity is the fact that taxes are calculated based on “net taxable income.” The system allows the use of any of the thousands of “allowable deductions” to reduce “gross income.” You take your gross income, subtract all the deductions you can find and then you have “net taxable income.”
A simpler and more equitable approach would be to eliminate any and all deductions and use “gross income” to calculate taxes. Taking this approach would immediately allow for a reduction in tax rates for everyone; except for those who formerly used enough deductions to pay little or no taxes. Simply taxing gross income would instantly eliminate the vast majority of the almost 80,000 pages of the current code that are dedicated to explaining the determination of “net taxable income.”
Using “gross income” as a basis for taxation would create a simple, fair and equitable flat-tax that everyone would pay. Under such a plan, the first $50,000 of gross income for individuals (married or single) could be exempt from federal income taxes. All gross income above the excluded amount would be taxed at a flat 12.5 percent. Zero deductions would be allowed.
There would be hue and cry about the loss of deductions, with mortgage interest and charitable contributions being put up as the poster-children to defend the old system, but they should be ignored. People will adjust. Remember when the deduction for all interest payments – not just mortgage interest – was rescinded? People complained, but they adjusted and items sold on credit were not impacted.
Which approach would you pick? A system that allows you to take multiple deductions from gross income but results in higher actual taxes or a system that allows no deductions, but results in paying less in total taxes?
One of the most persistent complaints about the current tax code is – believe it or not – its unfairness to corporations. The complaints are twofold: The current corporate rate is the highest in the world and is detrimental to doing business in America. The other complaint is that corporations are subject to an unfair “double-taxation.” The corporation pays taxes on its profits and then those profits are taxed again when they are distributed to shareholders in the form of dividends.
A simple solution to these complaints could be found by eliminating corporate income taxes altogether. After all, the Supreme Court and Mitt Romney have both declared that “corporations are people too.” So, for tax purposes, let’s treat corporations as people. No other business organization – sole proprietors, partnerships, Subchapter S or LLCs – pay income taxes, so why should corporations?
The way to eliminate corporate income taxes would be to treat them the same way all other business organizations are treated and that is by allocating all profits to the shareholders. Those allocated profits would be taxed at the individual rate of 12.5 percent; just as partnership and Subchapter S shareholders are taxed. This approach would automatically eliminate the “double-taxation” on dividends, because there would be no taxation on those profits at the corporate level.
The government must also do its part in eliminating this quagmire of a tax policy by living within its means. To accomplish this objective, the government should be mandated to adopt a triennial balanced-budget process. Except for natural disasters and declared war (the last formally declared war was World War II) the government must operate, provide its services and conduct its military adventures within a balanced budget. If the federal budget is in deficit then either the individual flat-tax rate would have to be increased or a specific tax (see below) would be required to eliminate the deficit. In and of itself, this should help control government expenditures. (Think “sequestration.”)
NATIONAL SALES TAX
A national sales tax of 3 percent on all goods and services would be enacted. All revenue collected from the sales tax would be mandated to pay for education, infrastructure renewal, national debt reduction, natural disasters and the costs of military actions, other than declared wars.
Even though those who buy the most pay the most in tax, a sales tax is by nature regressive; those with higher incomes pay a lower percentage of their income on the tax. To help adjust this, those individuals with less than $50,000 in gross income would receive a rebate on all sales taxes paid.
The most difficult aspect of these proposed changes to the tax system would be implementing them. Maybe the reason why it would be so challenging to implement these changes is because they would be simple, fair and equitable; causing the rich and powerful to have to pay their fair share.
And the Moral of the Story …
The best description of the current tax code is that it is so broken that it can’t be reformed or fixed and should be replaced. The fundamental pretext of the current system, calculating taxes based on “net taxable income,” makes it inherently complex, convoluted, inequitable and inefficient. Such a flawed system leads to an intaxacating addiction to the power of taxing.
The only solution is to treat the current system for what it is and trash it. The current system should be replaced with a new approach that returns to an old objective. And that is to adopt a system designed to pay for the government protections and services needed and demanded by the governed; with everyone paying their fair share. The intervention may be frightening and the cure difficult, but success would be intoxicating.