Our current system is called a progressive tax. An alternative is the flat tax. Which is better? Should we change systems?
The essence of a progressive income tax is that the rate of tax increases as income increases. For example, the tax rate on incomes up to $9,700 is 12% while the rate is 32% on income between $160,725 and $204,100.
It is the general consensus that the wealthy should pay more into the system than the poor. In practice, our tax system achieves this goal; the top 1% pay nearly 10 times what those in the lowest quintile pay.
Generally, citizens resent the time and expense of filing under the current system and also suspect that the maze of credits, deductions and exemptions gives a special advantage to the wealthy who can afford expert tax advisers.
A flat tax is a system in which everyone pays the same tax rate regardless of income. For example, with a 10% tax rate, a family with income of $70,000 would pay $7,000 in taxes while income of $7 million would be taxed $700,000.
Flat tax would be imposed on wages/salary only, meaning that there’s no tax on capital gains or investments. This can spur investment, savings and thus long-term economic growth. Additionally, many economists believe the current tax system, with high rates and discriminatory taxation of saving and investment, reduces growth, punishes job creation and lowers income.
How would a flat tax work for
individual taxpayers? Households get only one exemption, an allowance based on
family size, and then pay the flat rate on their income.
How would a flat tax work for businesses? All businesses, from the largest
multinational to a corner pub, would play by the same rules. Companies would
add up their receipts, then subtract their costs (salaries, raw materials,
plant operations, marketing, etc.) and pay the flat rate on net income.
The complicated documents, instruction manuals and numerous forms that
taxpayers struggle with today would be replaced by a brief set of instructions.
Proponents believe the entire tax code could be based on two simple
postcard-sized forms.
Currently the IRS has about 75,0000 employees and a budget of $12 billion. In spite of that resourcing, the “tax gap”, the amount of taxes owed that go uncollected, has been averaging $458 billion per year.
There would be an obvious advantage to having a tax system that EVERYONE can understand vs the current system that NOONE can understand. How did we get to where we are today?
The current tax code law is about 2600 pages. Then there are an additional 70,000-plus pages of regulations and tax-case history that are in play.
Special interest groups working through politicians have convinced them to insert numerous “tax breaks” into the law thereby creating the impression that the rich and influential have tax privileges.
Can we “fix” the current tax laws and regulations? No. It is not feasible to believe the Congress could work through 70,000 plus pages of law, regulations and judgements and end up with ground truth and simplicity. We could conceivably end up with a worse system.
With a pure flat tax, it is likely the single rate may be punitive to the lower and middle-class taxpayers. Remember, in spite of all the loopholes available to the wealthy, the top 10% still pay about 70% of all income taxes. Therefore, my recommendation is as follows:
Scrap the entire 70,000 pages of current law/regulations/legal judgements. Start over and create a simple, stand-alone, flat tax law that is 50 pages or less, explains in great detail exactly the income that is to be taxed, no deductions, no loopholes and can be filled out on one or two forms.
But, instead of having a single tax rate have a graduated flat tax rate. For example, zero tax for those below the official poverty line (About $11,000 single and $24,000 for a family of four). Then from the poverty line up to $75,000 in income, pay a 15% tax rate. For $75,001 to $150,000 pay 18% and so on until anything over $500,000 income pays 30%. The lawmakers need to lay out the graduated scale of income/tax rates and pass it as the new tax code law. Include in the law that it cannot be amended in any way by “earmark” legislation that is tagged on to an unrelated bill.
This could be the best merging of flat and progressive tax systems. There are four characteristics of a good tax system, certainty, equity, simplicity and efficiency. The current system gets an “F” in all four. A graduated flat tax system might be at lease a B+.
Lieutenant General, US Army retired, Marvin L. Covault is the author of Vision to Execution, a book for leaders.