Proposed Improvements To The U.S. Income Tax

Categories: Economy, Taxes
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Published on: 2016.01.02

So, since I don’t like the flat tax or the national sales tax — or what we have now — then what would I do (assuming I had carte blanche) with the tax laws? Glad you asked.

1. Redefine Income

Without question, the first thing I would do is rework the definition of income, starting with capital gains. Because of an artificial and arbitrary definition, income derived through capital gains is taxed differently than income derived from wages. The same is true for other types of income. The differences in the tax rates somehow always work out to benefit the wealthy, who are much more likely to derive income from these alternate sources, while hurting the poor and middle class, who almost always derive income from wages.

Due to capital gains tax cuts under Clinton and Bush I:

“Most of the richest Americans pay lower overall tax rates than middle-class Americans do. And this is one reason the gap between the wealthy and the rest of the country is widening dramatically.”

And:

“Most Americans depend on wages and salaries for their income, which is subject to a graduated tax so the big earners pay higher percentages. The capital gains tax turns that idea on its head, capping the rate at 15 percent for long-term investments. As a result, anyone making more than $34,500 a year in wages and salary is taxed at a higher rate than a billionaire is taxed on untold millions in capital gains… The 400 richest taxpayers in 2008 counted 60 percent of their income in the form of capital gains and 8 percent from salary and wages. The rest of the country reported 5 percent in capital gains and 72 percent in salary.”

Defenders of the low rates (from both parties) argue that the capital gains tax is “a tax on job creation”, despite there being no evidence of that. In fact, there is plenty of evidence that instead of creating jobs with extra wealth, those benefiting from low capital gains taxes are instead stockpiling cash.

There are other types of income too, each defined and taxed differently, including interest, dividends, pensions/annuities, rental income, farming and fishing income, unemployment compensation, gambling income, bartering income, scholarships, stock options, and more. As I see it, we need only two types — individual/household income and business income.

2. Increase The Progressive Nature Of Current Tax Rates

Our current income tax rates are “progressive”, in that the rates goes up the more you’re paid — but the slope isn’t as steep as it once was. The highest tax rate on wages was once as high as 92% in the days of Truman and Eisenhower, and was still as high as 70% when Reagan took office. The Tax Reform Act of 1986 knocked it down to a cool 28%, while the low-end rate rose from 11% to 15%.

(The current rates range from 10% to 39.6%.)

I don’t advocate for returning to a 90% income tax rate for the wealthy; it would be unnecessary, especially after we (as described above) tax capital gains and other forms of income at the normal rate. Somewhere in the middle should work, just high enough so we can shrink the rate at the low end and raise the $10,300 limit to a more reasonable amount, say $20,000.

(In fact, once we reduce loopholes and deductions, as I’ll subsequently describe, it should be possible to shift all the rates downward.)

3. Establish A Movable Baseline For Exemption

Currently, if you earn less than X dollars (the amount changes based on your status), you don’t have to report your income to the IRS for taxation. The highest amount on that list is $22,700 — if you’re over 65 and married, filing jointly. For a single person under 65, the amount is $10,150 — ridiculously low.

I would like to (1) establish an amount required to live — including rent, food, transportation, healthcare, etc., (2) not tax anyone making that amount or lower, and (3) make sure that amount rises proportionately when the cost of living rises.

4. Switch From Brackets To A Curve

In addition to lowering the rates for the lowest tax brackets and raising the rates for the higher brackets, I think we’re living in an age where we can end brackets once and for all, and make the entire thing into a slope or curve.

Currently, if you earn one dollar less than the top end of your bracket, you pay one rate, but if you get one hour of overtime you’re pushed into a new bracket with a new rate and end up paying a higher rate that more than destroys that hour of overtime.

True, this won’t happen to many people, and the average low-income or middle class taxpayer doesn’t pay enough attention to every dollar earned so they wouldn’t know if that extra bit of work at the end of the year will send them over (or if taking a few unpaid days off will actually save money in taxes). But, and this we all know, people wealthy enough to keep accountants employed seem to know exactly when to donate another thousand dollars to charity at the end of the year in order to save tens of thousands in taxes.

This is because of the bracket or “step” system. There are hard cutoff points at which a person switches from one tax tier to another. Eliminating those cutoff points would eliminate a lot of gaming the system and a lot of unexpected extra taxes for some.

Instead of our current seven-tier system, it could be a gradual increase from zero to whatever the top rate turns out to be. Such a gradual increase that there would be no cutoffs from one bracket to the next.

One argument against this is that it adds dreaded complexity to the code. I would rebut that it’s no more complex than what we have now, and would solve more problems than it creates.

5. End Most Deductions, Loopholes, Credits, Etc.

Likely, there are a few tax deductions that most of us agree are sensible, beneficial, or necessary. But I don’t think that case can be made for most of them. And here’s the kicker: every single one means the overall rate has to be higher, to cover the losses. Wouldn’t it make more sense to have a slightly lower rate and only half as many lines on your tax form?

I would start with corporate tax loopholes. It makes no sense when giant, profitable corporations pay zero taxes, or even get refunds. It further doesn’t make sense when two nearly identical companies, with nearly identical incomes, pay different rates — for example, from 2008 to 2010, UPS’s tax rate was 24 percent while FedEx’s was less than 1 percent.

When it comes to personal or household deductions, there are a number that were introduced with good intentions that didn’t actually help anything. Some are inherently unfair or nonsensical, including the marriage bonus (or penalty, depending). Two people, earning a total of X dollars, shouldn’t pay a lower (or higher) rate simply because they switch from dating to married. In my own case, my tax rate went down when I got married, despite the household income rising. This means I had been punished for being single.

There is a “mountain of academic research” showing the mortgage-interest deduction “makes no sense”. “The mortgage-interest tax deduction benefits the rich more than the poor, has little effect on home ownership and isn’t even really a bargain for homeowners because it raises home prices.”

The child tax credit (CTC) is similarly nonsensical. It was meant as a sop to “working families”, to “offset the cost of raising children”. It’s supposedly based on research that “suggests that boosting working families’ incomes can expand opportunities for children, such as by improving school performance”. Then why not actually boost their incomes? One easy way to do it is my #3 section above (don’t tax people if they’re poor enough to need help). And why does the CTC increase in value as earnings increase? That’s backward. Why is my family, with an above-median income in a low cost-of-living area, still receiving the full credit, the same amount as a household making half as much in a high cost-of-living area?

Instead of inventing deductions and credits that make taxes more complex for low-income families, the obvious answer would be to charge them less — or no — income tax (not to mention combining it with other progressive policies like a raised minimum wage and better guarantees of healthcare and education).

I’ve only mentioned a few loopholes here, but there are hundreds, if not thousands, that could simply be eliminated.

Increasing simplification of the tax code would have several benefits: (1) reduction of overall tax rates, (2) reduced market for expensive tax-preparation services, (3) fewer audits — since there would be fewer chances for mistakes, (4) less paperwork, (5) less opportunity and incentive to cheat, and — perhaps most importantly — (6) more voters would have a better idea of how the tax system works.

I can see only three beneficiaries of an overly complex tax code: (1) the wealthy, who can afford to find every loophole and shelter (and who lobbied to help write the code), (2) tax preparation services, which would be unnecessary if the code was simpler, and (3) elected legislators who get obvious benefits in return for helping their donors by writing new loopholes into law. The average American cannot possibly benefit from an overly complex system.

6. Simplifying Definitions

One reason many wage-earners balk at filing their own taxes is that they’re suddenly confronted with terms and definitions that are strange and unfamiliar. Even relatively simple terms like “dependent” have pages and pages of definitions and exceptions.

7. Cease Charging Income Tax To Federal Employees

The federal government employs nearly 3 million people (in other words, one in every hundred Americans works for the U.S. government). Their income tax goes to… pay part of their own salaries? Yes. In essence, the government spends money to pay its workers, the workers pay some of that back through payroll taxes, and then the government spends more when the IRS processes those 3 million tax returns, sometimes paying out refunds and sometimes having to collect. Not to mention the 3 million stacks of paper mailed about the country for this purpose. Just pay them X% less and exclude them from filing income taxes.

◊ Conclusion

Maybe you can think of more. These are just a few that popped into my head while I wrote my entry on the Flat Tax. My goal with these, as should be obvious, is twofold: (1) to make taxes less heinous for those who have the hardest time getting by, and (2) to simplify the entire system, which should make it more fair for everyone and save waste at every turn.

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