Trying to tax income fairly
I find “flat tax” proposals appealing. The only problem is, no one has ever proposed a true single-rate income tax, and even if we managed to get one through Congress by divine intervention or other supernatural means, it would probably get loaded with so many special preferences and exemptions during the next session of Congress that it would be no better than the tax law maze we have now. With that in mind, here is my (fantasy) proposal for a simple, fair income tax system:
- All income is taxed at the same rate. Whether you work for it, steal it, inheirit it, get it from successful investments or gambling in Vegas, income is income. This is an “income tax,” not “a tax on working people.” This simple redefinition of “income” cuts out half the ambiguity in the current tax code.
- You get to deduct mortgage interest on your primary residence. You don’t get to deduct mortgage interest on your ski lodge, motor home, sailboat, vacation condom or other secondary residence. No one is saying you can’t or shouldn’t own any or all of these things, just that you shouldn’t be able to deduct mortgage interest on them. I am not sure whether it would be right to cap the mortgage deduction amount. If it were capped, I would want to keep the cap rather high, possibly $1 million or more. (Since this is all a fantasy, it doesn’t really matter, does it?)
- The first $____ (fill in here) of income is tax-exempt. I mean exempt from all taxes on income, including the regressive “payroll tax,” which should not be separated from “income tax,” anyway. And yes, this means the “payroll tax” would apply to all income over the minimum amount, not only to part of a high-earning person’s total income or only to income that comes from work. All income above the minimum is taxed at the same rate, remember?
- Now that we’ve folded the “payroll tax” (which funds Social Security) into our one-rate payment scheme, we need to decide whether we want to allow deductions for savings and investments. I tend to favor this deduction, although I’d rather not tie it to specific goals like education, home-buying or retirement. I tend to favor a deduction for all money set aside instead of spent, as long as that money remains unspent for two years or more. I might want to put one limitation on this deduction: That it only applies to money invested in the United States, not in other countries. This might shut up some of the people who will jump on my savings deduction plan as favoring wealthy people, because this would encourage those wealthy people to invest their savings here. (If they choose to invest their money in China or Estonia, let the Chinese or Estonian governments give them tax breaks. That’s only fair.)
Sneaky note: taxing income but allowing deductions for savings and investments essentially turns “income tax” into “consumption tax” without turning businesses into tax collectors the way Europen-style VAT (Value-Added Tax) systems do.
- Negative income tax: It’s a much-abused part of the tax code, subject to massive fraud. But I have no good replacement for it, and one good thing about it is that if we combine it with a savings/investment deduction, it would encourage people on the bottom edge of society to save by giving them “negative income tax” on the amount they saved instead of reserving the savings/investment tax deduction only for people who earn enough to pay taxes in the first place.
- Business income taxes and deductions: That’s really beyond the scope of this article. Business tax law is currently so full of special credits, writeoffs, and loopholes that no one really knows what’s going on. Perhaps we should treat all companies as “S-Corps” for tax purposes, which would make them — in a tax sense — merely pass-throughs, with investors taking on all tax liabilities — and getting all tax benefits — as individuals rather than making the corporation itself a taxable entity. This would be eminently fair. Bill Gates would pay heavy taxes whenever he exercised stock options or sold shares, but a retiree living on Social Security selling off $3000 worth of Microsoft shares to pay a medical bill would pay no tax on that income, not even indirectly through corporate taxation. We all want to encourage people of modest means to invest, right? Treating all corporations as “S-Corps” would help do that.
- Charitable deductions: I rather like them, and I would extend them to people who pay no tax in the form of negative income tax, same as I want to extend savings/investment deductions to people with modest incomes. A person earning $15,000 per year in a hard labor job should have just as much encouragement to give to charity as someone who gets $10,000,000 per year from a family trust fund.
- Children and marriage: A single-income domestic partnership, whether it is called “marriage” or something else, should have a higher start-paying-taxes threshold than a single person. Children should also bump the threshold. And child support payments should bump the payer’s threshold by the amount paid; right now child support is not tax-deductible — and that’s silly if we are truly committed, as a society, to making sure non-custodial parents pay a fair share of the expenses involved in raising their children. (Strangely enough, alimony is deductible.) It will be hard — even impossible — to keep religion out of discussions about how families are taxed, and even what a “family” is, but we should try.
This is the framework for what I believe would be a truly fair tax system. Someone who earns $50,000 per year from work pays the same rate as someone who gets $50,000 by investing $1 million at 5 percent per year. Everyone gets the same incentives to save, invest, and give to charity. The only preference is for those at the very bottom of the income pyramid, out of practical recognition that it’s easier for those of us with substantial incomes to pay substantial taxes than it is for those with marginal incomes to pay any tax at all.
Yes, the top-to-bottom incentives for saving and investing essentially turn this into a consumption tax, but by building a “negative income tax” into the system we encourage people with very small incomes to become savers and investors instead of only rewarding prosperous people for saving and investing — and since all sources of income are taxed equally, workers don’t feel they are getting cheated while people who inheirit their money or get lucky with investments aren’t paying their fair share.
Complaints about “double taxation” on inheiritances and capital gains would be eliminated. If Aunt Sadie leaves you $5 million and you invest it within the United States, you pay taxes only on any part of your ineheirited capital you decide to spend rather than save or invest. This protects family-owned farms and small businesses from being broken up to pay inheiritance taxes, while preventing revolution-inciting displays of rich heirs squandering money on which they have either paid no income tax or paid a lower total rate than is paid by a fast-food worker.
My overall idea is to be fair, keep things simple, and encourage economic behavior the vast majority of Americans agree is good. For example, we seem to have a national consensus that home ownership is desirable. We at least pay lip service to the idea that it’s better to put money into savings than to borrow endlessly. We say we want to encourage business growth and entrepreneurship, and we claim we want our government to have a balanced budget.
Well… maybe we don’t want our government to have a balanced budget, since hardly anyone running for federal office right now has any kind of sensible plan to pay off our national debt. But I suspect that if, instead of seeking tax preferences at the expense of other Americans, we all paid our fair share of the government’s costs, we would see more public interest in fiscally-responsible government.
Or maybe we wouldn’t. I’ve damn near given up on the American electorate and the political system that gives us choices like the current presidential one between Bush and Kerry, neither of whom I personally feel is fit to hold our nation’s highest office. But one can hope.