Simplify Taxes

Although some tax increases may eventually be needed to help balance the budget, SAFE believes that all reasonable options for cutting spending should be exhausted first.

#Tax rate increases would yield less “revenue” than expected due to changes in taxpayer behavior and drag effects on the economy. 

#Such “revenue” increases as were achieved might serve as a pretext for more Government spending rather than being used to balance the budget.

Does this mean the tax system should be kept as it is?  No, because the current system has many problems.

#Excessive complexity - The Internal Revenue Code grows longer and more complex with every session of Congress.  Just think of all the nonproductive effort to interpret and hopefully comply with its provisions (as supplemented by thousands of pages of IRS Regulations, Revenue Procedures, Revenue Rulings, etc.).

#Erratic application – Due to the exemptions, deductions and credits that are available, over half of Americans pay more in Federal payroll taxes (to cover their Social Security and Medicare benefits) than in income taxes (to cover general costs of the Government).  Indeed, many people pay negative income taxes (receive money back) due to the Earned Income Tax Credit and other “refundable” tax credits.

 #Double taxation – The earnings of large businesses are typically taxed twice, once at the corporate level and a second time (albeit currently at a reduced rate) when paid as dividends to shareholders.

 #Alternative minimum tax (AMT) – Originally enacted in an attempt to ensure that wealthy taxpayers could not use available “loopholes” to avoid all tax liability, the AMT is becoming applicable to more and more taxpayers because the specified income thresholds were not indexed for inflation.  Unless the law is changed, millions of middle class taxpayers will be forced to calculate their tax twice, once on the regular basis and the second time on the AMT basis, and pay whichever bill is higher.

 #Noncompliance – There is some cheating with any tax system, but the Federal income tax has worked reasonably well over the years due to a high level of voluntary compliance.  Given the foregoing problems, however, voluntary compliance is eroding.

 If Congress decided to overhaul the tax system, how should they go about it?  Three approaches seem worthy of consideration.

 Option One: Radical Overhaul – Restore the role of the Internal Revenue Code as a vehicle to raise revenue vs. fostering social policy goals.  Eliminate the AMT, Earned Income Tax Credit, and corporate tax provisions designed to favor particular industries or types of business operations. Severely prune the list of available tax deductions (or eliminate all of them), but exclude half of dividends and net capital gains from taxable income.    Use a single graduated tax rate table (reducing rates so the overall effect will be revenue neutral).

 Comment:  The pressure from special interest groups to preserve tax treatment of benefit to them would be tremendous, for which reason the results achieved might fall short of expectations.

 Option Two: Flat Tax – In addition to overhauling the Internal Revenue Code (option one), replace the graduated tax rate table with a single tax rate (e.g., 17%).

Comment: In addition to the objections noted above, a flat tax would be challenged as regressive because lower income taxpayers would not get a break on the rate.

 Option 3: “FairTax” - Eliminate Federal income, payroll (and also self employment), corporate and death taxes (but not excise taxes on petroleum products, etc.), replacing them with a Federal sales tax (“the FairTax”) levied at a rate (perhaps 23% of purchase amounts) designed to raise the same amount as the several taxes eliminated. 

 Because the FairTax would be levied on consumption expenditures vs. income, it would be harder to evade by workers paid in cash.  Income tax returns would be eliminated vs. merely making them easier to prepare.  The repeal of existing tax laws might be easier politically than overcoming entrenched resistance to amending them. 

 To temper regressivity, consumers would receive, in equal monthly installments, an annualized rebate on poverty level (determined by the Government for the household size) expenditures up to the poverty level at the FairTax rate.  Thus, a worker who consumed the poverty level amount would pay zero tax.

 Comments: (1) Elimination of payroll taxes would break the existing linkage (however imperfect) between the amount of Social Security and Medicare taxes collected and the benefits these levies are supposed to cover.  This could make it tougher to restructure these programs as SAFE advocates.( 2) Since the purchase of new homes (but not existing houses) would be subject to FairTax, there could be a devastating initial effect on the residential construction industry.  (3) The country might wind up with a federal sales tax and a federal income tax! (FairTax advocates assume a Constitutional amendment to preclude Congress from imposing income taxes in the future, but achieving such an amendment might be easier said than done).  (4) Implementation of the rebate program would create substantial possibilities of fraud and the intrusion of the government into many lives.

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