Monday, February 07, 2005

Tax "Reform"

Another cornerstone of Bush's domestic agenda is tax "reform" - code for another tax cut. It will be given in the guise of the simplification of the tax laws, something that even I admit would be a good thing.

Bush's ideas seem to revolve around a couple of ideas, both of which are bad. The first is a "flat" tax, something that's been kicked around since the Gingrich era and even before. On the surface, this seems fair. Everyone pays a certain percentage of what they make, no ifs, ands, or buts. The rich pay more since they make more; the poor pay less since they make less. Everybody's happy, right?

Wrong. What flat tax advocates fail to realize is that as income decreases, the percentage of your income spent on essentials increases. So taxing someone who makes $20,000 a year and someone who makes $200,000 a year at the same rate is absurd - in the first case, you're taking away money spent on food, rent, water, and other necessary expenditures, while in the second case you're taking away disposable income that would otherwise be spent on luxury items (or saved). A flat tax, then, would hit the poor far harder than the rich, and lead to more income disparity.

Bush's second idea - a national sales tax - would be even dumber. Sales taxes are the ultimate in regressive taxes, since they tax necessary purchases and luxury items the same. Since the poor, by necessity, spend a higher percentage of their income, they will be taxed at a higher rate than those who can afford to save and invest. Fortunately, the idea of a national sales tax seems DOA in Congress.

I agree that the tax code needs to be simplified, if for no other reason than to make compliance a lot easier. However, some semblance of progressivity needs to remain if we are to have a fair tax system. Since I don't believe in disparaging Bush's solution without providing one of my own, I propose the following: a flat tax based on disposable income. "Living wage" information is available for most jurisdictions - these data can be used to calculate the least amount of income necessary to survive for a given family situation in a given place. (Here in Raleigh, it's $11/hour, or $22,000/year, for a single person living alone.) Also, a tax credit (akin to the earned-income tax credit) could be issued to those who make less than a living wage. Any income beyond the living wage is disposable income and is taxed at a flat rate - and no deductions whatsoever.

This system maintains progressivity at the lower income levels while making the tax code a lot simpler. It may not be a perfect idea, but it's a start. Of course, no one with any power to propose such a system would be reading this. But we can dream.


Anonymous said...

And right now, other people are blogging about their relationships with their girlfriends or the Superbowl or something less....policy. Something requiring less thought.

- Ben

Mike said...

Thank you for making that point, Ben. I have decided I won't blog about my girlfriend after all.

Jeff, your proposal is interesting, but somehow it sounds familiar, I can't quite put my finger on why. It is certainly important to factor the cost of essentials into any tax code, and no fair tax system could ignore such considerations. I definitely agree that Bush's tax reforms will do more harm than good (though I must admit from a purely selfish perspective it's hard to argue with his tax cuts). Still, I have neither the economic know-how nor really the creativity to come up with an alternate solution.

Bottom line is, if we're gonna get serious about tax reform, we need to get serious, and throwing around oversimplifying terms like "flat tax" and "tax cuts" will hardly accomplish much. We, the American people, have chosen the government "we" desire, and now it's all in their hands. We just get to wait and see what they do.

Anonymous said...

It appears that everyone on earth wants to overhaul the tax code to make it fair and simple. It seems to me, that, first we the people have to decide whether we want the income tax to be a "revenue generator," only or whether we want to continue using the internal revenue code as a means for creating backdoor social programs and as an economic stimulus. I would venture a guess that 99 percent of deductions, credits, and other adjustments are all directed toward promoting or discouraging social programs instead of "leveling" the tax burden. Our first decision, then, needs to be if we want to continue hiding social programs behind revenue generation. It is, somehow, more palatable, at least to politicians, to provide tax deductions or credits, etc. rather than to eliminate those deductions and just give the money directly to those who are now getting the deductions. My guess is that the notion of the tax system as a hidden social program is too deeply ingrained to ever allow any really meaningful changes.

alte Holzkopf

Anonymous said...

Of course, we could just make everything easier on ourselves and repeal the 16th amendment. If anything it would get rid of the IRS, one of the most morally repugnant and thugish organizations known to man.

- miguel

Anonymous said...

As much as I would love to see tax cuts, I really think we need to decrease spending at the same time or before. The obvious counterargument would be "well, if we cut taxes then they'll have to decrease spending", but preposterously that has not proven true in the real world. For all his rhetoric, Bush has increased the raw size of the federal government at the same time he has decreased tax income. Apparently he thinks he can just warp money in from the future.

In other words, government programs will find ways of getting the money they "need" one way or another, and if we don't fund them with taxes then they resort to (if you can believe it) even more insidious income sources. From the manipulation of economic variables that no one but Greenspan understands, to selling bottles of refined sugar to our fat kids, to flat-out criminal activity.

But yeah, simplification of the tax code to something more straightforward but still reasonable would be an excellent start, because then more people could actually understand the taxing and funding process, and start caring about how that money is spent.

- Pierce

Anonymous said...

I don't quite get this - surely there is nothing inherently 'complex' about a progressive income tax that would need simplifying? Theoretical example - your income is exempt up to amount A. Between A and B, it is taxed 10%. Between B and C it is taxed 20%. After C, it is taxed 30%. The complexity of the tax code is surely loopholes and exemptions and deductions and the sort of crap that means accountants are the only ones who can do tax returns. To replace progressive rates with any sort of a flat tax is automatically either sacrificing revenue, or asking the poor to bear more of the tax burden (after all, the flat tax can hardly be set at the top marginal rate) and quite possibly both.

- Tim

Jeff said...

Yeah, most of the complexity in the tax code now comes from deductions, credits, and all those other little things that, as Dad said, act as social programs buried in the tax code. The argument for simplicity is that it'll raise compliance rates, thus making a tax cut or spending boosts more economically viable, and making economic predictions easier. It'll also decrease the size of the IRS, which frees up some budgetary money too. Tim, the problem with your idea is that it becomes better to make slightly below C than slightly above it. That's a problem.

Anonymous said...

I'm not sure that is what happens. The only time there would ever be a net disincentive to earn above a certain income, is if the marginal rate went to 100% or more. As the marginal rate increases, the incentive to earn more might be reduced, but never eliminated. In other words, people still want to have more money, and the more they earn the more they will have. Additionally, and maybe I'm not aware of any counter-evidence, but the number of people in the top income brackets has been rising even with progressive income tax systems in the Western world. Certainly a top rate of 40-50% isn't anything that seems to have retarded income growth or desire to earn money.

Jeff said...

Tim - I agree, it's somewhat foolhardy to think that a progressive income tax system is going to make someone want less money. If anything, it oughta increase the incentive to earn more. My problem comes with the immediate terrace in the tax. Say the dividing line between the 20% and 30% rates is $100,000/year. Then someone who makes $95,000/year will take home $76,000 after taxes, but someone who makes $105,000 will take home only $73,500. So it's better to make $95K than $105K in that situation. I like the flat rate based on disposable income because it's still progressive and it eliminates this sticky situation.

Anonymous said...

Jeff - It's been a while since I did economics, but I don't think that's how the progressive tax system works (at least, not in the UK). Let's say the threshold for the 10% tax is $30,000, for 20% is $60,000 and for 30% is $100,000. A person earning $95,000 a year will pay 0% on his first 30K, 10% on his second, and 20% on his last 35K, leaving him with a net income of $85,000. A person earning $105,000 will pay nothing on his first 30K, 10% on his second, 20% on his next 40K and 30% on his last 5K, leaving her with a net income of $92,500. Or does the US tax system operate on a different model? - Tim