Five Easy Principles: A Fair Tax Proposal
In the same way that war is too important to be left to the generals, I believe taxes are too important to be left to politicians. The size and content of the tax code is testimony to the power of special interests at the expense of simplicity and fairness. Whatever our differences, we all pay taxes and care about the tax systems. I propose here a major modification to our income tax system that is based on several principles that, I believe, most people can agree on, at least in general terms. The goal is to design a general structure that is impervious to the machinations of special interests and politicians; a people's tax policy. I ask that you suspend judgement until having considered it in its entirety because it will only makes sense, and seem fair, when all of the elements are in place.
I believe that most citizens would agree in principle that:
I. There is a maximum tax rate above which taxes are excessive.
II. There is a minimum income below which a person should not have to pay taxes.
III. All money is of equal value.
IV. Tax policy should be about raising money for government programs.
V. All “persons” are created equal.
These principles can be the basis for a fair and equitable income tax program. To see how, I explain below what I mean by the principles and show how they become the basis for a fair tax system.
I. There is a maximum tax rate.
Most people would agree that there is, or ought to be, some maximum income tax rate. While people may have various ideas about what constitutes a fair rate, a survey several years ago by Readers Digest suggested that most people thought a rate above 25% was too high and unfair. Suppose we had a national referendum to determine the maximum rate, and for the sake of this discussion, let’s say the most popular value was 33%. (We could use range voting as probably the best way to determine the most widely held value.) This value will become central to this tax program.
II. A minimum taxable income.
Again, most people would probably agree there is a minimum income below which a person shouldn’t have to pay taxes. Some possibilities include the poverty level and the point at which it costs as much money to collect the tax as the money collected. Some may say every one should pay taxes, irrespective of income. Again, I propose we have a national referendum and decide the issue for ourselves. For the sake of the discussion here, let’s say the chosen value is the poverty level.
With just these two principles in hand, it is possible to lay out the basic structure of a tax policy. These two values, plus only one more, completely define a workable tax system. The tax rate is simply a linear function of income, starting a 0% tax at the poverty level income and increasing to 33% tax (our assumed maximum rate) at some (as yet undetermined) income level. A graph of the tax RATE as a function of income looks like the figure below.
All that’s left to fully determine taxes is to decide at what income the maximum tax rate is reached. We can leave that to Congress. They can adjust it so as to insure the necessary income. BUT THEY CANNOT CHANGE THE MAXIMUM RATE OR MINIMUM INCOME.
Whatever other objections one might have, this tax rate structure has obvious benefits over other tax simplification proposals such as a flat tax. While still simple it preserves the progressive tax policy that has long been a generally agreed upon feature of income tax. Further, it eliminates stair step tax rate increases which are fodder for special interests and create disincentives for additional income.
III. Money is money.
Money IS money, and it doesn’t really make any difference how you got it. Whether it came as a gift, as wages, as capital gains, or whatever, if you get money, you can spend it as you see fit. So I propose that ABSOLUTELY ALL INCOME be included in what gets taxed. No more special consideration for this kind of income or that; it’s all the same. If you received money (or equivalent instruments, goods, services, etc.) it’s taxable.
IV. Taxes are about raising money for government.
Taxes should be about raising money for government operations only. Taxes should not be about family planning, or savings, or social policy. Paying taxes is a shared obligation of citizenship and one of the most ubiquitous aspect of government that links all citizens. It is an essential basis of our social contract: the idea that we, as a people, have common goals which we share the expense of attaining. Everyone paying his/her fair share is central to that idea and fairness is a fundamental value held by all. When taxes are seen as unfair, the "system" is seen as corrupt.
Under the present system, every time a deduction or allowance is created, someone benefits and somebody else looses. So I suggest that just like all income is taxable, there will be NO DEDUCTIONS. Why should I get a deduction for my home mortgage interest and you not for your rent? Why should a medical bill be deductible and an education expense not? All such items are put into the tax code either to benefit some group with the clout to get it there or as a consolation prize to those without power to keep them quiet. A great deal of politics is primarily about taxes. If we eliminated that, perhaps we could attend to other important issues.
V. All “persons” are created equal.
This is the really radical part of the proposal. The quotes are to bring attention to the fact that there are two kinds of persons in the U.S, people and corporations. Corporations were originally intended to be just legal constructed “persons” for business purposes, hence the same root as corporeal, i.e., a body. But over time two classes have evolved and present tax law heavily favors corporations. What I mean by this principle is that all the exact same rules that apply to people should apply to corporations. Therefore, all corporate income would be taxed and there would be no deduction for business expenses either. That is, corporations would be taxed on their gross income, not net. The only exception to this would be wages (and all other compensation) directly paid to employees and officers. (This would also apply to private individuals as well: if you pay a housekeeper W-2 wages, those would be deducted from your income since the housekeeper would be paying his/her taxes on that money.)
Just as there is no objective basis for what is a legitimate expense for a private citizen to deduct, the same applies to business. What makes supplies, depreciation, lunches, etc. legitimate expenses and others not? The true answer is power and politics. Let’s get entirely out of the business of making some expenses cost less because they are deductible. This practice ultimately distorts spending and diminishing incentives for minimizing costs. The fundamental idea to keep in mind is that whenever Congress creates a deduction, it doesn't make just one. There's always something else in the proposal, ostensibly to make it fair to some group, but most likely it's really to pay a political debt to a donor somewhere. As Warren Buffett has said, every line in the tax code has it’s champion(s).
If these principles were scrupulously followed, then I believe a very interesting thing would happen: Taxes would no longer be a very important economic consideration for both people and businesses. Indeed, I don’t have the data to calculate this, but my bet is that the maximum tax rate necessary to provide our present Government services might be less than 33 percent and that rate wouldn’t be reached until a fairly high income. Doing taxes would take about 20 minutes and the tax rate would be low enough that businesses and people would make decisions based on what made economic sense, rather than on what the effect on their taxes would be.
Given that I am by no means a tax policy wonk, what I have proposed here may have missed some important considerations. I welcome any suggestions. I hope that they would confirm to the guiding principle of this proposal: It attempts to create a tax plan without consideration of how it effects any individual person (or corporation.)
By way of beginning the discussion, I want to suggest two modifications that I thought of recently.
1. Allowing the tax rate to "go negative" for incomes lower that the poverty rate would allow payments to the poor similar to those provided by the EIC. This system has the added advantage that there would be no critical points where incentives would change substantially.
2. Once a basic maximum tax rate were chosen, it could be adjusted automatically by some formula that caused it to vary inversely with respect to changes in the GDP. If GDP increases, the max tax rate goes down. Perhaps this would incentivize the rich to avoid bubble making. If the GDP decreases, increased taxes would provide income for stimulus programs. Although this idea might have multiple unintended consequences, the idea of an automatic feedback system has a certain appeal. Perhaps economist could devise one that we could agree on.