Well, once again the dreaded Tax Day has come again in the United States. As millions scramble to finish their returns at the last minute, and millions more are reminded for a moment about how painful, frustrating, and stupidly complicated this year’s taxes were, perhaps you will give me a moment to indulge a fantasy:
Imagine there’s no 1040
It’s easy if you try
No capital gains tax
Eating away our pie
Imagine all the people
Keeping all their pay…Imagine there’s no AMT
It isn’t hard to do
Nothing to evade or cheat for
And no Schedule-C too
Imagine all the people
Earning cash in peace…You may say I’m a dreamer
But we’re growing every day
I hope someday you’ll join us
And the world will keep its pay!
(With no apologies to Lennon, that socialist twit.)
While many taxpayers are lucky enough to use 1040-EZ (as long as they don’t mind missing out on half the deductions allowed), anyone who has ever: bought a house, received any money for contract work, sold any stock, earned any sizable amount of interest, earned any dividends, used a car or possession for business, or done any of a hundred other fairly common things knows the joy of the full 1040. And that’s a joy that they get to enjoy for a longer time each year, as the code grows in complexity.
This year, in fact, we were treated to the wonderful spectacle of a recursive function in the capital gains worksheet: Box 22 depended upon Box 10, Box 10 depended upon Box 37, and Box 37 (naturally) depended upon Box 22. A literal Catch-22 right there in the 1040! So what did the taxpayer do: why fill out boxes in order over and over again until the numbers stopped changing. Yes, this year’s tax form required iterating over a recursive function. It’s official: advanced mathematics is now required to accurately fill out an American tax form. I guess we should just be thankful the function converges…this time.
So, enough whining. What should we do?
No band-aids, no simple patches like the mid-80s reforms, no more kicking the problem out for another decade or so. Scrap the cobbled together, rickety, ideologically-driven, overly-intrusive, economically regressive thing, and start again.
But what to replace it with? The Flat Tax? The Fair Tax? The As Yet Unknown Tax? No Federal Tax? (That last one’s for states rights fanatics like Angry Midwesterner.) Before I try to lay out a positive, let me shoot down some perennial red herrings:
We can’t have a [flat/Fair/no] tax – it’s regressive!
Now this objection can have a reasonable meaning, which is: the very poor must use the vast bulk of their money for necessities, and the very rich use almost none, so a tax code should respect that each tax dollar is a greater burden on the poor than the rich. And that reasonable objection has a simple and reasonable answer: set a personal deduction large enough to ensure that the poor pay little or no tax.
Sadly, most fans of “progressive” taxes don’t give a damn about the poor—they’re besotted by the sin of envy and want to soak the rich and damn the cost! For these folks, the answer above is worthless because it only benefits the poor, it doesn’t punish those evil, evil rich. You’ll pardon me if I see no reason to respect the wishes of a bunch of folks eager to punish the deadly sin they hate (greed) by enshrining the one they love (envy) in law.
Any tax code we come up with will just get hijacked again—and be just as complicated soon!
This is actually very reasonable, and a useful cautionary warning. But as an objection to doing something it’s pretty wrongheaded. Just because every system can be abused doesn’t mean that some aren’t better than others. Given that the current code kills a sizable forest every time they need to print a hard copy of it, I find it very hard to believe that much simpler systems will somehow be easier to corrupt.
Now is not the time for radical reform—we have massive deficits and are in a recession!
No, now is exactly the time for change, especially if those things are true. Taxes are, almost always, regressive economically: the more taxes the less growth and the greater the chance of recession. Lower taxes, and you spur growth. Ah, but simplify taxes, and you reduce the burden of complying ($200-$500 billion dollars annually), which lowers the effective tax burden (taxes plus fees to file taxes). So a simpler system would spur growth even without lowering taxes. Anyone who’s run their own business, done contract work on the side realizes this. The current system burdens the self-employed with significant costs.
So, away with these objections, and on to the glorious future!
Well, actually, I don’t have a nicely laid out, detailed plan for tax reform any more than anyone else does. But, to avoid the label of coward, I’m willing to stick out my neck and recommend a general outline of one. First the general principles: the poor should not pay tax (they’re poor), those who work should not be punished (they’re industrious), those who invest should not be punished (they generate capital), those who start businesses should not be punished (they are the engine of growth).
So, the plan:
- A flat income tax of 25% Easy to calculate, easy to file.
- A standard personal deductible of $20,000 per adult and $5K per child. Make less than that? No tax for you. Creates these effective tax rates:
Effective Rate by Income $20K $35K $50K $100K $250K $1 million Single 0% 11% 15% 20% 23% 24.5% Single Parent (2 children) 0% 3.5% 10% 17.5% 22% 24.25% Family (2 children) 0% 0% 0% 12.5% 20% 23.75% Progressive!
- No capital gains tax. (That’s right: 0%! Don’t whine too much though, lefties, look on down the page.
- No tax on interest or dividends. (That’s right: 0% But wait, progressives, you’ll get your day!)
- No corporate taxes. (That’s right: 0% here too! Think about it: corporations don’t pay taxes, they just pass those taxes on to shareholders, customers, or employees. If they simply avoid taxes through clever bookkeeping. Breathe steadily, lefties, good news follows!)
- Earned Income Tax Credit: reward the working poor who are stuck, for the moment, with low-paying jobs. Exact mechanic to be worked out, but we should be generous while always making it more profitable to take a better job!
- Nothing else. No other deductions. No tax loopholes. No tax shelters. No tax-free trusts. No mortgage deductions. You get a personal deduction, you pay 25% on what’s above it. That’s it.
Now, before I’m hauled outside, doused in environmentally friendly fair-trade organic vegetable oil, and set alight, let me point out why this is a win for the soak the rich crowd:
Who pays taxes in America? Despite campaign rhetoric, it ain’t the poor. In fact, it’s the rich. The top 10% of income earners (those making $103K and up) control around 46% of the wealth but pay over 70% of the taxes! This means, of course, that most of those nice deductions, exclusions, etc. benefit the wealthy. A 25% rate might seem like a tax break, since the current top rates range from 28% ($77K-$160K) to 35% (above $350K), but those rates on on taxable income—after deductions have had their day. A 25% rate on all income above $20K should compare pretty favorably to 28% on income left over after well above $20K in deductions have been applied.
So why would the rich approve? Because a flat tax allows them to calculate their burden easily, estimate the economic costs of various options easily, avoid expensive tax preparation and record-keeping, and eliminate the expensive audits or penalties which arise from the inevitable mistakes in the current ridiculously complicated tax environment.
And, best of all, eliminating compliance costs and flattening rates will spur an economic boom. Wealth, individual income, and tax revenues will rise, and the tax base will grow as new workers enter the pool.
My numbers are rough, and doubtless need fine-tuning. We’ll need a bunch of work to get things right, and we’ll have to work across the political divide to get a tax code that rewards hard work and investment without unfairly hurting hard-working blue-collar folks. But we can do it! We can revolt against this bloated tax code shoved upon us by a political class of lawyers and lobbyists and return to something simple and sensible. Fourteen states have done it, seventeen nations have done it, and we can do it too!
You may say I’m a dreamer
But we’re growing every day
I hope someday you’ll join us
And the world will keep its pay!
The 12 Angry Men Blog 
April 15, 2008 at 9:06 am
Absolutely love this article and will be linking to it from my blog. As a self-employed person, I know the pain of all these extra forms and the confusion involved even when using tax software. Even after paying estimated quarterly taxes, I still had to cut a check for $3200.00 today. What will I be using me “rebate” for when it arrives? It’s going right back to the government to cover estimated taxes for 2008.
April 15, 2008 at 9:15 am
Yes, the estimated tax is the worst nonsense of all. I was trapped into it one year due to an error on withholdings (as I was working at multiple places and didn’t realize that the tax shortfall was going to be quite that much).
So I feel your pain, and I think if more citizens went through that there’d be a real revolt in short order. As a friend said, “The IRS really does think it’s all their money, and they’re just giving some back to you.”
April 15, 2008 at 9:18 am
[…] I found this great article that I recommend reading that has some great points and a pretty reasonable solution: https://12angrymen.wordpress.com/2008/04/15/end-the-tax-nightmare-red-herrings-and-true-reform/ […]
April 15, 2008 at 9:26 am
The rich would love your scheme — without taxes on capital gains, plenty of them pay practically no taxes whatsoever, since in your system capital gains aren’t income.
The gap in earned income in this contry is not so large. Hedge fund managers, for instance, make little more than you or I in terms of earned income. When you add capital gains, this is where the rich make the big difference over all of the rest of us louts.
Even the likes of the Economist, no home for wimpy lefties, has begun to argue that capital gains do not deserve a preferential treatment in the tax code.
Your plan would look much less like a plan to hand a giant check to the rich at the expense of the middle class (you at least had the dignity to spare the poor) if you considered all income as equal.
April 15, 2008 at 9:41 am
Actually, believe it or not, I thought a bit about that, and I agree with the concern about the super-rich making little or no income outside of capital gains.
But here’s the problem: if you treat capital gains like any other income there is far, far less incentive to place money at risk. Consider two investments of $1 million:
1) A CD, backed by a global bank, or spread across numerous banks to take advantage of FDIC insurance ($100K per bank): makes 3% and no risk.
2) Investing in a good starting company with excellent prospects, but moderate risk: makes 10-30% but has a 1% chance of total loss.
Right now, under current law, the top marginal rate for income is 35% and for capital gains 15% Making the rates equal cuts deeply into the current profits of the capital investment without reducing the risks at all. Thus, for any reasonable investor it reduces the attractiveness of the investment.
And since capital is essential to drive the economy, it also invites economic ruin, because the super-rich don’t have to invest in risky investments (or in risky investments in the U.S.). Encouraging them to put less money at risk or to place it at risk in foreign countries is probably not a great plan.
As a counter-proposal, allow me to suggest 10% capital gains rates, which ensures that the super-rich pay some on their earnings, while making those risky investments fairly attractive. (And 10% is a nice traditional number!)
April 15, 2008 at 1:31 pm
AOC: There is no question that a lower capital-gains tax is an incentive to invest. The question is how muCch of an incentive is it. From what the Economist has said, it doesn’t appear to be all that much of an incentive, but I’m unaware of any real quantitative research done on the subject. Some countries, like Estonia for instance, tax capital gains like anything else, but there are few developed countries which have attempted the practice.
While the economic gains from simplifiying the tax code are non-trivial, in the current climate, any tax rate you choose will have to be almost revenue neutral. Barring increase in system efficiencies (which, as you note, are substantial), and additional tax dollar saved by Bill Gates and Warren Buffett will have to be paid by Angry Overeducated Catholic and Angry New Mexican. The fatal flaw with any “simpler” taxation scheme is that it almost always does exactly that.
Would you be interested in crunching some numbers with me sometime as a follow-up article to see if a variant of this plan could actually be (almost) revenue neutral?
April 15, 2008 at 2:00 pm
I would be really leery of getting rid of capital gains as a special category, especially as globalism creates increasingly attractive investment opportunities around the world. Since the true rate of return is always “raw interest – expected risk – taxes” every 1% bump in the capital gains is an effective (I/100)% reduction in the raw interest rate I.
As a result, increasing the rate too much actually reduces revenue, as folks opt out of investment. But, there is a range of capital gains rates (above zero) where revenue is maximized while impact to the economy is minimized. At least some analysis would seem to suggest that this optimal rate is around 10-15%.
Would you be interested in crunching some numbers with me sometime as a follow-up article to see if a variant of this plan could actually be (almost) revenue neutral?
Certainly. My numbers were basically a rough first-pass, and you’re certainly right that we’ll need to be nearly revenue-neutral to have any shot at getting real reform through.
Of course, the one thing you cannot simply do is hold the pie fixed as the changes are made. Reducing capital gains may increase income revenues, as, for example, additional investment hires additional workers. Converse, increasing capital gains could reduce total revenues if the economy suffers a more severe downturn as a result of the change.
But we could at least provide some analysis about how the current numbers compare with the plan numbers, which is a key starting point.
April 15, 2008 at 2:46 pm
[…] End the Tax Nightmare: Red Herrings and True Reform Earned Income Tax Credit: reward the working poor who are stuck, for the moment, with low-paying jobs. Exact mechanic to be worked out, but we should be generous while always making it more profitable to take a better job! Nothing else. … […]
April 15, 2008 at 2:47 pm
Since the true rate of return is always “raw interest – expected risk – taxes” every 1% bump in the
capital gains is an effective (I/100)% reduction in the raw interest rate I
True, but the pool of good investments is finite. There’s a limit to how much “capital flight” from America can be absorbed by the rest of the world economy…
April 15, 2008 at 3:36 pm
Doubtless the pool of foreign investment opportunities is finite, but I suggest that we don’t want to empirically discover whether the pool is deep enough completely destroy the American economy…
And keep in mind that you’re not just competing with foreign opportunities, you’re also competing with safe opportunities like bonds and CDs. Tax-free bonds, in particular, will become much more attractive. Also, you’re competing with very risky domestic investments, whose high rate of return offsets the tax burden.
A belief that nearly doubling the capital gains tax will not have a dramatic effect on the economy strikes me as far more voodoo economics than the worst supply-sider fantasies. The economy is not a fixed entity, and tax policy is among the top factors.
April 15, 2008 at 3:41 pm
As a final caution, the whole AMT fiasco was started as a “soak the rich” campaign by the Democrats to target a handful of super-rich who were evading income tax. I’d think very carefully before walking down the exact same path: targeting the small number of super-rich income-tax evading investors with a blunt tax instrument like capital gains.
It’s one thing to protest that a 0% capital gains is both too stingy for revenues and unfairly privileges those who don’t have traditional income. It’s quite another to argue that offering no incentives at all for risky investments will have little adverse effect on the ecomomy.
I don’t think our first experiment in this exercise in empirical macroeconomics should be with the United States economy…
April 15, 2008 at 4:22 pm
I don’t think our first experiment in this exercise in empirical macroeconomics should be with the United States economy…
Agreed. Germany is moving to a 25% capital gains tax (with some limited exceptions, like real estate held over 10 years) in 2009, and Australia has taxed (realized) capital gains as income for some time now, so there should be enough data for economists to make some good predictions before we start playing games with the world’s largest economy.
I’d mention that Sweden taxes capital gains at 30%, but compared to their income tax, that’s a steep discount.
At the end of the day, taxing capital gains is not a “soak the rich” issue, it’s a “make sure we’re not giving the rich an advantage nobody else has” issue. A truly “flat” tax would treat all income equally.
April 15, 2008 at 4:36 pm
At the end of the day, taxing capital gains is not a “soak the rich” issue, it’s a “make sure we’re not giving the rich an advantage nobody else has” issue. A truly “flat” tax would treat all income equally.
You know, this is really the most effective argument to use.
Sure, I want to encourage investment, but that’s the same argument as granting mortgage deductions, EIC, child tax credits, privileged retirement plans, and a host of other things. All of them seek to encourage certain behaviors and either persuade people to spend money on them or support those who choose to do so.
However, some of these are important enough that maybe we should write them into the tax code. You’ll notice that I granted tax credit for children (because producing a new generation is important to national security ;)), an EIC (because encouraging and supporting work is the only proven method to reduce poverty), and a 0% interest income tax rate (to encourage savings).
I think a low or 0% capital gains rate is exactly the same, until you get to those who make all or nearly all of their money through investments.
Maybe I should take a page from my own book: tax capital gains at some rate, say 15% but add a $100,000 personal exemption. So the first $100,000 in capital gains is tax free. That provides major incentives for all but the mega-rich, and the 15% rate provides plenty of incentive for them too!
April 15, 2008 at 4:37 pm
Best of all, you can still file it out with a hand calculator on a (slightly larger) postcard!
April 16, 2008 at 10:26 am
An encrypted, secured postcard with a special security stamp.
Maybe we could add some sort of tax on the stamp — that’s a classic…
April 29, 2008 at 10:45 am
Am I too late in the discussion to start my sales tax rant again?
I find the argument that sales taxes are regressive in nature to be all wet, at least if you differentiate between living expenses (food, clothing, etc) and luxury items (flat panel TV’s, new cars, etc).
In an increasingly environmentally conscious world, it seems like the thing to do would be to set up taxation based on consumption, rather than production.
And, let me add, anyone advocating state-run taxation as a simplification has never filed taxes in Minnesota!
April 29, 2008 at 3:04 pm
Oh, it’s never too late to start ranting, though nobody may be listening to us! As I see it, there are essentially two problems with luxury taxes:
1. How to differentiate? Are all food items essentials (including cavier)? At what price point does clothing move from one category to another?
Nothing says this can’t be solved, but it leads to (another) massive set of government regs or (another) massive bureaucracy to make the call. And if you think the current tax code encourages give-aways, shelters, and ham-fisted tax “incentives”, just think what the ability to move an item from the X% to the 0% column will do!
2. By definition, luxuries are, well, luxuries, so taxing them may drive down purchase—especially if you only tax new purchases. This of course impacts those who make luxury items, who are usually working class. It also depresses the economy, since many of the luxury categories you mention are also significant consumer categories.
So, while it may not be directly regressive, it will probably put a bunch of working joes out of work, which doesn’t sound very progressive!
April 30, 2008 at 9:43 am
[…] gains, tax | On April 15th, tax day for millions of Americans, Angry Overeducated Catholic posted some, I believe, common sense observations and recommendations on the tax system. One of our […]
May 1, 2008 at 12:29 pm
Ask the New Englanders what they think about luxury taxes. The ‘lets soak the rich’ crowd put a luxury tax on yachts and essentially killed the industry. Put something like 25,000 of the labor force out of work. See post.
May 15, 2008 at 1:21 pm
[…] Well, they call them stimulus checks, and I’m stimulated alright…to get rid of the IRS! Or at least make taxes simple, straightforward, and clear. […]
May 21, 2008 at 1:23 pm
[…] Politics, Stupid Politicians, tax On April 15th this year, Angry Overeducated Catholic posted on a subject dear to all of us (on April 15th at least): the Income Tax. By way of some simple math (actually […]
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