Tax Reform for a Broke Nation

Jon N. Hall

Now that the debt ceiling deal is done -- or at least done until Congress must break through the new ceiling -- some want to move on to tax reform.  In addition to the effectiveness and enforceability of new tax systems, the issue of fairness should also be addressed. 

One idea for tax reform is to institute a national sales tax.  The rationale behind this is, in part, to get revenue out of those who operate in the underground economy and therefore don't pay income and payroll taxes.  Some advocates of this tax want to add it on top of all the other taxes we're already paying.  So those who earn their living in the aboveground economy and who pay income taxes will also be hit by an additional tax. That doesn't seem fair.  A fairer tax would target the tax evaders in the underground economy and let those who are already paying taxes alone.

Another type of national sales tax is the FairTax, and it would replace existing taxes rather than be added on top of them. (Read my reservations about the FairTax here.) 

I have a problem with having to pony up money for the privilege of using my money. Which explains my aversion to sales taxes. It's why I have a credit card that doesn't charge me anything as long as I pay off my bill in full at the end of every month. I want to pay my taxes up front, be done with it, and then be free to roam the country without having to worry about what it's going to cost me to use my money.

Taxes shouldn't be a major consideration when one is buying something or they'll put a damper on sales. And with all the moaning from progressives that consumers aren't buying anything, sales taxes seem a nonstarter. Rather than adding new taxes on top of the old taxes or replacing the old tax system with a new system (like the FairTax), let's try actually reforming the old system. The idea out of the Bowles-Simpson commission is to "broaden the base and lower the rates." 

For the 1979-2001 period, the share of individual income tax liabilities taken up by the "Top 1%" topped 30 percent for the first time in 1996, and in 2000 it hit 36.5, the high for the period (Table 1B of a 2004 paper from the Congressional Budget Office). In 2007 the "Top 1%" paid more than 40 percent. The general trend for decades has been for the top few percent of taxpayers to pay more and more of total income tax revenue.

The portion of Americans who don't pay the federal individual income tax -- the feds' largest source of revenue -- is around 50 percent. America has reached a dangerous tipping point where the majority isn't contributing. 

But the situation is actually more acute, because the lowest quintile of taxpayers "pays" the negative income tax; that is, the I.R.S. sends them money. (With the negative income tax, the feds pay you for existing, but with the ObamaCare's individual mandate to buy health insurance, the feds "tax" you for existing. One might doubt that Congress has some unifying philosophy to explain it all.)

Whenever it's pointed out that the lower half of "taxpayers" don't pay taxes, progressives usually howl that they do so pay taxes: payroll taxes.  But currently, a third of payroll taxes aren't collected. And former Labor Secretary Robert Reich wants to totally exempt the first $20,000 of income from the payroll tax. 

It would seem the political left doesn't want most Americans to pay taxes.  But won't the majority of the citizenry degenerate into parasites, thinking of the government as only a dispenser of free goodies and associating the filing of Form 1040 as only a way to get money from the feds?  It's easy to see where this will lead; just look across the pond at the riots in Britain.

I support a graduated income tax, where rates go up in tandem with income.  But I also believe everyone should pay something to Uncle Sam. Having such a large portion of Americans getting a "free ride" hurts not only the character of individuals, but the character of the nation as well. 

From 1979 through 2001, the effective rate on the individual income tax for the "Top 1%" never went above 25 percent (Table 1A, CBO link above). The highest effective rate on the "Top 1%" during this 23-year stretch occurred in 1996 and in 2000, when it hit 24.2 percent. The top statutory rate at the time was 39.6 percent. So during the Clinton years, the smallest difference between the effective and statutory rates was 15.4 points.

The way to reform individual income taxes is to simply set the statutory rate to the last known effective rate and eliminate every last exemption in the tax code. Such a change would, theoretically, be "revenue neutral." 

Keep in mind that an effective rate is an average. So if income taxes were simplified as just outlined, some taxpayers would actually be paying less. Those same taxpayers are currently paying more because they don't take advantage of the myriad exemptions. In effect, they are making up for those who do avail themselves of exemptions.

Having any exemption in the tax code invites adding more exemptions. We saw this with the 1986 tax reform bill, exemptions eventually made their way back into the code. 

Some argue that we need to keep the exemption for home mortgages. But our current tax system encourages homebuyers to buy more home than they can really afford. And why should those who rent have to subsidize those who buy their dwelling?

Some also argue that we should keep exemptions for charitable contributions. But that's entirely discriminatory. If the religious can give to their churches and get exemptions, where does that leave the irreligious? Well, subsidizing the religious. Congress has no business making these kinds of decisions -- it's another case of Congress picking the winners, and they're just not smart enough to do that.

Allowing the same Congress whose insane spending has cost America her AAA rating to decide who gets an exemption and who doesn't is in itself insane. Congress shouldn't bribe Americans into doing what's charitable -- it debases us. If Congress wants to favor certain individuals, enterprises and behaviors, then they should do so with direct grants, not with exemptions in the tax code. 

If there is any area where tax reform in America should be tackled immediately, it is the corporate income tax.  America needs to become a good place to do business again, and we just became the nation with the highest corporate tax rate in the world.

A perfectly rational argument can be made that corporations shouldn't even be paying income taxes, as companies just pass the overhead of taxes onto customers.  But let's leave that alone for the time being and commit to lowering the rate to 25 percent or less. A 25-percent rate on corporate income would be 0.8 percent higher than the top effective rate on individuals during the vaunted Clinton years.  And, as Mitt Romney just informed a leftist heckler in Iowa: "Corporations are people." 

Federal taxes are a monstrosity. Congress created this monstrosity. The way to slay the monster is to take Congress out of the picture by creating a tax system that has no escape hatches, no carve-outs and no favors. We need a tax system that treats people and enterprises with more -- what's the word? Oh, right: fairness.

Jon N. Hall is a programmer/analyst from Kansas City.

Now that the debt ceiling deal is done -- or at least done until Congress must break through the new ceiling -- some want to move on to tax reform.  In addition to the effectiveness and enforceability of new tax systems, the issue of fairness should also be addressed. 

One idea for tax reform is to institute a national sales tax.  The rationale behind this is, in part, to get revenue out of those who operate in the underground economy and therefore don't pay income and payroll taxes.  Some advocates of this tax want to add it on top of all the other taxes we're already paying.  So those who earn their living in the aboveground economy and who pay income taxes will also be hit by an additional tax. That doesn't seem fair.  A fairer tax would target the tax evaders in the underground economy and let those who are already paying taxes alone.

Another type of national sales tax is the FairTax, and it would replace existing taxes rather than be added on top of them. (Read my reservations about the FairTax here.) 

I have a problem with having to pony up money for the privilege of using my money. Which explains my aversion to sales taxes. It's why I have a credit card that doesn't charge me anything as long as I pay off my bill in full at the end of every month. I want to pay my taxes up front, be done with it, and then be free to roam the country without having to worry about what it's going to cost me to use my money.

Taxes shouldn't be a major consideration when one is buying something or they'll put a damper on sales. And with all the moaning from progressives that consumers aren't buying anything, sales taxes seem a nonstarter. Rather than adding new taxes on top of the old taxes or replacing the old tax system with a new system (like the FairTax), let's try actually reforming the old system. The idea out of the Bowles-Simpson commission is to "broaden the base and lower the rates." 

For the 1979-2001 period, the share of individual income tax liabilities taken up by the "Top 1%" topped 30 percent for the first time in 1996, and in 2000 it hit 36.5, the high for the period (Table 1B of a 2004 paper from the Congressional Budget Office). In 2007 the "Top 1%" paid more than 40 percent. The general trend for decades has been for the top few percent of taxpayers to pay more and more of total income tax revenue.

The portion of Americans who don't pay the federal individual income tax -- the feds' largest source of revenue -- is around 50 percent. America has reached a dangerous tipping point where the majority isn't contributing. 

But the situation is actually more acute, because the lowest quintile of taxpayers "pays" the negative income tax; that is, the I.R.S. sends them money. (With the negative income tax, the feds pay you for existing, but with the ObamaCare's individual mandate to buy health insurance, the feds "tax" you for existing. One might doubt that Congress has some unifying philosophy to explain it all.)

Whenever it's pointed out that the lower half of "taxpayers" don't pay taxes, progressives usually howl that they do so pay taxes: payroll taxes.  But currently, a third of payroll taxes aren't collected. And former Labor Secretary Robert Reich wants to totally exempt the first $20,000 of income from the payroll tax. 

It would seem the political left doesn't want most Americans to pay taxes.  But won't the majority of the citizenry degenerate into parasites, thinking of the government as only a dispenser of free goodies and associating the filing of Form 1040 as only a way to get money from the feds?  It's easy to see where this will lead; just look across the pond at the riots in Britain.

I support a graduated income tax, where rates go up in tandem with income.  But I also believe everyone should pay something to Uncle Sam. Having such a large portion of Americans getting a "free ride" hurts not only the character of individuals, but the character of the nation as well. 

From 1979 through 2001, the effective rate on the individual income tax for the "Top 1%" never went above 25 percent (Table 1A, CBO link above). The highest effective rate on the "Top 1%" during this 23-year stretch occurred in 1996 and in 2000, when it hit 24.2 percent. The top statutory rate at the time was 39.6 percent. So during the Clinton years, the smallest difference between the effective and statutory rates was 15.4 points.

The way to reform individual income taxes is to simply set the statutory rate to the last known effective rate and eliminate every last exemption in the tax code. Such a change would, theoretically, be "revenue neutral." 

Keep in mind that an effective rate is an average. So if income taxes were simplified as just outlined, some taxpayers would actually be paying less. Those same taxpayers are currently paying more because they don't take advantage of the myriad exemptions. In effect, they are making up for those who do avail themselves of exemptions.

Having any exemption in the tax code invites adding more exemptions. We saw this with the 1986 tax reform bill, exemptions eventually made their way back into the code. 

Some argue that we need to keep the exemption for home mortgages. But our current tax system encourages homebuyers to buy more home than they can really afford. And why should those who rent have to subsidize those who buy their dwelling?

Some also argue that we should keep exemptions for charitable contributions. But that's entirely discriminatory. If the religious can give to their churches and get exemptions, where does that leave the irreligious? Well, subsidizing the religious. Congress has no business making these kinds of decisions -- it's another case of Congress picking the winners, and they're just not smart enough to do that.

Allowing the same Congress whose insane spending has cost America her AAA rating to decide who gets an exemption and who doesn't is in itself insane. Congress shouldn't bribe Americans into doing what's charitable -- it debases us. If Congress wants to favor certain individuals, enterprises and behaviors, then they should do so with direct grants, not with exemptions in the tax code. 

If there is any area where tax reform in America should be tackled immediately, it is the corporate income tax.  America needs to become a good place to do business again, and we just became the nation with the highest corporate tax rate in the world.

A perfectly rational argument can be made that corporations shouldn't even be paying income taxes, as companies just pass the overhead of taxes onto customers.  But let's leave that alone for the time being and commit to lowering the rate to 25 percent or less. A 25-percent rate on corporate income would be 0.8 percent higher than the top effective rate on individuals during the vaunted Clinton years.  And, as Mitt Romney just informed a leftist heckler in Iowa: "Corporations are people." 

Federal taxes are a monstrosity. Congress created this monstrosity. The way to slay the monster is to take Congress out of the picture by creating a tax system that has no escape hatches, no carve-outs and no favors. We need a tax system that treats people and enterprises with more -- what's the word? Oh, right: fairness.

Jon N. Hall is a programmer/analyst from Kansas City.