Game Theory, Individual v. Collective, Taxes, Trust

It’s Time For a Fair Tax

If 67,000 pages could be a microcosm, the U.S. tax code demonstrates so much of what is wrong with this country. The tax code is confusing, divisive, superfluous, and esoteric at times. Libertarians would call it highly immoral and it absolutely fosters the lobbying culture in Washington where everyone is seeking a break and a handout. If individuals even had time to become familiar with all 67,000 pages, the average American wouldn’t understand it. So why do we do this to ourselves? Or rather, why does our government do this to us?

Taxes could be this simple…fill in the blanks:

Total income = $X
State tax rate = Y%
Federal tax rate = Z%

State taxes = $X * Y%
Federal taxes = $X * Z%

Now I know there are people out there who struggle with math. But I’m pretty sure they could figure this out, or find help from some good Samaritan who could help them punch this into a calculator.

If you wanted to have graduated tax brackets, and a progressive tax system, the government could make a table available online for income cutoffs and associated tax rates to use in this uncomplicated plan.

Taxes shouldn’t be rocket science. There shouldn’t be an entire profession dedicated to deciphering the tax code and doing people’s taxes for them. It is an unbearable waste of human capital, time, and energy. Thinking about the creative energy lost every year in this country due to becoming compliant with our tax code is astonishing. It is a burden on our lives, an unnecessary source of stress and fear, and something none of us should tolerate any longer. Intuitively we all understand this come tax time every year.

There should be no deductions, tax credits, write-offs, and other manipulations meant to facilitate handouts to certain people or industries (corn ethanol and hybrid cars anyone) or drive capital to certain parts of the economy (housing perhaps, through the incentive of deducting interest). There are so many different sources of taxes including personal and corporate income (an offshoot being capital gains), payroll, property, sales, excise, gift, estate, etc. Obviously it is all with the goal of generating ample revenue to fund both necessary and unnecessary projects. In doing so, the taxpayer is increasingly on the hook to pay for the debt of past projects and the newest “must have” initiative for the public welfare.

In the following Seinfeld clip, Kramer hilariously admits to Jerry, like many of us, that he has no idea what a write-off is:

Amen Jerry. I’ve spent copious amounts of time preparing my taxes, worrying about my taxes, and fearing the Internal Revenue Service (IRS) that I’d like to have back. The tax code as it stands is insane, and our affluent leaders themselves can’t even comply with it. I think in the midst of the worst economic conditions since the Great Depression, it’s safe to say we have enough to worry about. The quick fill-in-the-blank method above would be appreciated.

Yet there is an even easier and more efficient way for government to collect tax revenues: a Fair Tax; a single broad national consumption tax on retail sales to replace all federal income taxes. A Fair Tax would be collected by merchants and then distributed to the government. Imagine it: a world with no tax returns for individuals, only for retail businesses. It sounds so simple. Surely it wouldn’t work, or wouldn’t produce enough revenue, or somehow make the United States fall to her knees, right? Well, no actually, simple works just fine in this case.

A Fair Tax would be progressive, given the assumption that the greater one’s income and net worth, the more they consume. So not to worry “social justice” crowd, the rich will still pay more. Before April 15th this year, a study by the Tax Policy Center was cited estimating that 47 percent of taxpayers owed no federal income tax for 2009. Many conservative talking heads clasped onto the statistic and claimed that “47 percent of all Americans don’t pay any taxes.” All the more reason not to watch TV news. Conservative people proclaim figures like “the top 10% of income earners pay 70% of taxes” all the time. It is actually more nuanced then that. These figures deal in federal income tax, and as highlighted above, there are a bajillion different types of taxes. When opened up to consider total taxation at the local, state, and federal levels, our tax system isn’t nearly as progressive as the conservative shills make it sound.

Source: Citizens for Tax Justice

 

Source: Citizens for Tax Justice

As Citizens for Tax Justice puts it:

It’s true that many taxpayers don’t pay federal income taxes, but they still pay federal payroll taxes (and some federal excise taxes) and also pay state and local taxes. Most of these other taxes are regressive, meaning they take a larger share of a poor or middle-class family’s income than they take from a rich family. This largely offsets the progressivity of the federal income tax.

Why hasn’t a Fair Tax happened already? Despite more traction in recent years, it still remains on the relative outskirts. People have been pushing it since at least 1994 with substantial resources. I imagine the Fair Tax remains on the back-burner because such a system would limit the politician’s ability to acquire power, influence, and wealth, as well as redistribute that wealth. Some politicians claim a Fair Tax would not yield enough revenue. Fair Tax supporters have produced studies suggesting the plan would be revenue-neutral at a 23% consumption tax rate. Even if revenue was less, I view that as a good thing. It would force government to cut spending. Recently Federal Reserve Chairman Ben Bernanke testified that federal debt “…is already expected to be greater than 70% of GDP…at the end of 2012.” And that by 2020, “…federal debt would balloon to more than 100% of GDP,” provided taxes are not raised and budgets are not cut. Needless to say, cutting spending might be a smart idea here real soon. It also would be smart to explore new ways of increasing government revenues. The Laffer curve tells us that at some point, tax revenues decline as a result of increased tax rates. As we stare down the barrel of a jobless non-recovery, it would be smart to at least attempt to widen the tax base without increasing income taxes on the wealthier end of society. They tend to be the folks creating jobs. Call me crazy, but maybe we should stop doing the same things over and over again and expecting different results. The tax code is no exception.

The Fair Tax movement has come up with a rebate plan, where lawful U.S. residents receive a check every month equal to the estimated total Fair Tax paid on poverty level spending, as outlined by the The Department of Social and Health Services (DSHS). These prebates, as they’ve been coined, would help people purchase some of the basic costs of living tax free. They would also partially offset the regressive feature of the Fair Tax on income, while eliminating and reimbursing all federal taxes for those below the poverty line. The Fair Tax is regressive on income because eventually a person’s income gets high enough to where they tend to spend less of each additional dollar. Now you always have exceptions like former NBA player Antoine Walker who went bankrupt after $110 million of career earnings. Walker was underwater on at least two multi-million dollar estates in Miami and Chicago, and rumors have him trying to keep up gambling with Michael Jordan. Some rich people do actually spend all their money. But most do not spend the same percentage of the 1,000,000th dollar they earn in a year as they do the first. Recall, though, that the Fair Tax is progressive on consumption, and that it is a consumption tax. As discussed above, low and moderate income Americans pay far more in FICA taxes (payroll/employment tax) than income taxes. This means that those spending at twice the poverty level would pay a Fair Tax of only 11.5 percent, which is lower than the income and payroll tax burden they bear today.

The Fair Tax has been designed to only replace federal income taxes. Tax policy at the state and local levels would not be effected by it, although, whose to say the plan couldn’t be tweaked so that states, cities, and counties could be covered by consumption taxes, too? My chief concern is with federal income taxes because they are subject to tax code that could fill the FDR Presidential Library. Beyond that, DC itself is a cess pool. Until there’s a paradigm shift in culture there, we’re not going to achieve meaningful solutions to the multitude of problems we face on a national level. That is why scrapping the tax code is essential. It creates many special favors and handouts, which breeds the lobbyist culture. If we moved to a Fair Tax, not only would each and every one of us get back hours and days of our lives doing taxes every year (or the accountant’s lives), there would no longer be a lobbying community in Washington.

One major weakness of the current tax system is that it relies on people both reporting their income honestly, and, understanding the confusing, endless rules to become compliant. How many people would you say achieve both? The IRS also takes billions of dollars to fund in order to oversee and enforce the current system. By eliminating all individual tax returns, there will be far less for the Treasury to oversee making them more efficient and effective. The IRS racks up $265 billion a year in compliance costs and still comes up $350 billion a year short of what is owed.

The entire underground economy, from the drug trade to the organ commodities market, does not directly contribute to the federal tax base. Stolen money and goods do not directly contribute to the federal tax base. And people choosing not to report income from what may be legal endeavors does not contribute. Illegal immigration can also result in unrealized income as the government doesn’t necessarily see any of the fruits of their labor. A consumption tax would capture revenues from the good old fashioned dishonest, criminals, and illegal immigrants working under the table. It would also allow workers to keep their entire paychecks and retirees to keep their entire pensions and retirement savings accounts such as 401(k)s and IRAs. In a country driven by consumption, and a world where fifty somethings just lost half their net worth, this would be an especially appealing tax system.

The efficiency of collecting tax revenues from retail purchases makes sense on every level. No more lobbyists, no more fights about new taxes, an honest system both from the administrator and citizen point of view, ease, cost-effectiveness, and peace of mind. If the government ever cared about the peace of mind of their citizens, this would be the way to show it. We could phase out the current system over time, say a 5-year period of reducing the current tax burden and implementing the consumption tax. We could make sure the consumption tax produced sufficient revenue (increasing it if need be). Let’s stop allowing politicians to use tax favors like currency and misallocate resources through the tax code. Let’s get our financial mess in order and tax citizens what we need, in one manner, to cover the basics. Let’s stop playing class warfare and opt instead for simplicity and fairness.

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5 thoughts on “It’s Time For a Fair Tax

  1. scottgreene says:

    The current Income Tax code is close to 70,000 pages long
    But that is just the Income Tax code itself.
    But because this code is NOT written in understandable English, the government then has to issue thousands and thousands and thousands and thousands more pages of Revenue Rulings, Private Letter Rulings, Tax Memorandums, Tax Publications, etc. in order to explain exactly what these 70,000 pages actually mean.

    But it doesn’t stop there.
    You then have thousands and thousands and thousands and thousands more pages of Tax Court cases where citizens argue with its government employees over what the Tax Code, Revenue Rulings, Private Letter Rulings, Tax Memorandums and Tax Publications actually mean.
    Then Tax Court judges chime in and give their opinion on what it all means.
    Sometimes citizens and/or its government employees will then appeal a Tax Court ruling and take their case to an Appeals Court and in some cases all the way up to the Supreme Court.

    And all these court cases are there to determine the following:
    what is taxable at what rate, what is not taxable, what is deductible, what is not deductible, what is depreciable and for how much and how many years, what is not depreciable, what is capitalized, what is not capitalized, what is amortized, what is not amortized . . . it goes on and on and on and on.

    This is the “system” that our government uses to fund itself.
    It is pretty unbelievable.

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  2. Josh says:

    “As we stare down the barrel of a jobless non-recovery, it would be smart to at least attempt to widen the tax base without increasing income taxes on the wealthier end of society. They tend to be the folks creating jobs.”

    Jobs creators in America tend to be the middle class, obviously the rich have corporations but they’d much rather optimize their employees incomes and fire as many as possible while not losing production values instead of keeping people gainfully employed. The middle class and small businesses are what this country needs to get back on track. Also, I like how you’re calling for fair taxes and talking about revamping the economy while at the same time admitting to wanting to kill an entire field of workers (CPAs and accountants).

    Other than that, very infomative post.

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    • @Josh

      Small business provides roughly two thirds of American jobs. What you define as “rich”, “middle class”, etc. is subjective.

      Entrepreneurship and innovation is what this country needs to get back on track. Obviously there is a lot of this going on, but there needs to be much more. See here. Part of encouraging more entrepreneurship is not making regulations onerous and burdensome. Once you own a business, you always gain a different perspective on red tape than an employee/consumer. It can be a nightmare. There is a need for some regulation, but, in general, I think we sprinted past that line long ago.

      Almost every accountant I’ve met I liked. They tend to be very smart people. Honestly, I’d rather have them utilizing their talents in other areas than doing people’s taxes. Part of innovation is adjustment. Technological innovation, for example, makes our lives better AND takes jobs away in the present. But that means you are freed up to do something else. Would it be better to go back to an agrarian society where everyone farms? We’d all be employed, but I would venture to say no. Thank god for farming equipment. There is never a revamping or progress without adjustment.

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