Reform the Tax Code with a Flat Tax

I think that everyone would agree that our current tax system is a failure. It is extremely complicated, very time consuming (or expensive) to figure out what you owe, and it has too many loophole that allow legal tax evasion. In addition, the corporate tax rate is a major contributing factor in jobs leaving our shores. I propose a flat tax system, where loopholes and deductions would be minimized, and everyone would pay the same rate on all earnings, be it wages, dividends, or capital gains. Before explaining my proposal, an understanding of our current screwed-up system is necessary.

Our Current System

I am amazed at the number of times I here average, middle class people lament about the wealthy not “paying their share” and then criticize any attempt to eliminate the very system that creates that situation. Our current system is rigged to benefit the wealthy, due to high taxes on wages, and relatively low taxes on investments. Lower and middle class individuals earn most, if not all, of their wealth through wages; for the wealthy investment income is the primary form of income. And not only are the taxes low on investment income, but there are many ways to legally avoid taxes altogether. Of course, since the poor in this country are eligible for all sorts of government assistance, we have the infamous “middle class squeeze”. Compare the following tax rates:


CURRENT FEDERAL TAXES ON YEARLY SALARIES
 
INCOME RANGE
TAX RATE
0-8,375
10%
8,376-34,00
15%
34,001-82,400
25%
82,401-171,850
28%
171,851-373,650
33%
373,651 AND ABOVE
35%
 
 
CURRENT FEDERAL TAXES ON INVESTMENT INCOME*
 
INCOME SOURCE
TAX RATE
LONG TERM CAPITAL GAINS
15%
CAPITAL GAINS, REAL ESTATE
25%
LONG TERM CAPITAL GAINS, COLLECTIBLES
28%
SHORT TERM CAPITAL GAINS
35%
DIVIDEND INCOME
15%
*This is based on an individual who is in the 35% bracket
 

NOTE: I am not going to chart a table showing the corporate tax rates, as they are even more confusing and screwed up than the individual’s rates. Rates range from 15-39%, although certain business must pay an additional 15%, no matter what the income level, while other business have received sweetheart deals from the government and pay no corporate taxes.

As you can see from the tables, every form of investment income (except for short term capital gains) has a lower tax rate than the rate for salaried income. On top of that, there are plenty of places for the wealthy to shelter their investments from taxes. For example, investments in municipal bonds are tax free. And while municipal bonds do not have an incredibly high return on investment, it is an excellent tax shelter for the wealthy.

What this creates is a system where it is difficult to become wealthy, but relatively easy for the wealthy to maintain their wealth. In essence, what we have is a lock on the clubhouse door. And raising taxes on investments really wouldn’t solve anything, as the wealthy would simply shift their investments around to tax shelters. And the numbers from the IRS confirm this.

A Stanford Professor and Economist, W. Kurt Hauser, has been studying the relationship between federal tax revenue and the GDP since the early 1990’s. If you look at the federal tax revenue from the 1950’s to present, the federal tax revenue has ranged from 17.9% to 20.6% of the GDP. That is quite a tight range, when you consider that the top marginal rate has ranged from 92% (1952-53) to 28% (1998-2000). In simple terms, if you want to increase federal tax revenue, you need to grow the GDP. How much growth in the GDP will take place if investors are investing in municipal bonds?

A System that Favors Economic Growth

The federal government should not discriminate the tax on earnings based on where the income came from, or what the current income level is. A flat tax would have overall lower rates with no loopholes. This would both fulfill the “equal justice under the law” principal, as well as promoting economic growth. Here is how they system would work:

  • All income, no matter what the source, is taxed at a flat rate. Corporate, wages, dividends, capital gains….all the same. I would suggest a 15% rate, but that number could be adjusted as needed. It would be nice to get the GDP up and federal expenditures down so that the rate could be below 10%.
  • A $15,000 personal deduction would be the only deduction (married couples filing jointly would get $30,000). We do not need to reward individuals (or corporations) with behavior that fulfills some politician’s political goal (or attempt to get reelected).
  • To level the playing field and eliminate loopholes, there are no additional deductions or tax shelters, including municipal bonds. Believe me, the state and local governments need no encouragement to go into debt.
  • Instead of the current 850+ tax forms, there would be two postcard-sized forms: One for salaried income and one for business/investment income. For individuals, you would basically take you gross income and subtract your personal deduction. Multiply this by the tax rate, and you have your yearly taxes. Subtract what was withheld from your paycheck, and you have your refund or the amount you owe. The business/investment form would be based on the same idea, although instead of a personal deduction, business expenses would be deducted instead.

Besides being pro-growth and the fairness of the system, simplicity is one of the great benefits of the flat tax. With such a simple system, mistakes on tax returns would be greatly diminished. As a result, the IRS would need a much smaller staff to conduct audits, and the audit process would not be the long, agonizing process it is today. In the case of individuals, it would simply be the case of a math error or typo, and would easily be fixed. Businesses would not spend as much time and money on tax prep, and business decisions would no longer be based on tax consequences.

The United States needs to reform its tax code, and it needs to do it now. I can see no better system than the flat tax.

I hope you have enjoyed this article. Please feel free to leave comments below. Be sure to stop by my blog at TheThriftyNation.com for great money-saving advice!

CATO video on flat tax

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Comments 9 comments

poorconservative1 profile image

poorconservative1 5 years ago

I like your attitude toward paying taxes. But think about this, if we eliminate income taxes altogether and create a national sales tax, we only pay taxes on what we buy and not what we earn. Which in turn gives tax payers/consumers more earning power. And by national sales tax I don't mean a V.A.T. (Value Added Tax) that was introduced by the democrat super majority in the last election cycle. With it's multi level taxation concept it would potentially harm our economy. I enjoyed this Hub. I voted it Up. Thanks

Chuck


AJReissig profile image

AJReissig 5 years ago from New Richmond, Ohio Author

I agree with you on a national sales tax. My only issue with the national sales tax has to do with trust. Once a Constitutional Amendment to allow a national sales tax passed, I think the politicians would find some excuse to keep the income tax as well. The only way I could see it working is if the Constitutional Amendment granting the right to a sales tax also repealed the 16th Amendment. So, I agree with you that it would be an even better system, but I don't have the level of trust in our politicians to implement it.

Thanks for the comment!


Harlan Colt profile image

Harlan Colt 5 years ago from the Rocky Mountains

I agree with AJReissig in part. I don't trust our politicians either, however, I would strongly support a national sales tax or flat tax, and the elimination of the IRS etc. I would love that.

- Harlan


AJReissig profile image

AJReissig 5 years ago from New Richmond, Ohio Author

A sales tax would be great in that we could eliminate the IRS; that would be a pretty big savings to the tax payers. I think we can agree that either a national sales tax or a a flat income tax system would be an improvement over what we have now.


LRCBlogger profile image

LRCBlogger 5 years ago

This is a vote up for me, well done. I agree that eliminating deductions and moving to a simpler flat tax rate is the way to go.

All Tax forms should literally be one page.


Jed Fisher profile image

Jed Fisher 5 years ago from Oklahoma

Hey, I found something I can agree with. An across-the-board flat tax, no excuses, no loopholes. That would do it. The revenues would be immense. And I hate the "admnistrative supervision" of having to file taxes, the whole process is just way too nosey, a real intrusive invasion of my privacy.

As a side note, in South Korea, (I lived there for a while) there is no income tax. Their government seems to be doing all right with just import tariffs and corporate taxes.


AJReissig profile image

AJReissig 5 years ago from New Richmond, Ohio Author

Jed,

Thanks for the comment. At one time we made it on just tarrifs and land sales....yes, it can be done!


dani5302 3 years ago

It makes too much sense, therefore it will never happen


akrongarber 3 years ago

I know there are only 2 forms of "Fair Taxation" one is a consumption (or Sales Tax) and the other is a flat Rate (my personal favorite). I have even stated that ALL forms of income (including welfare) should be taxed at the same rate. However, I am not sure about the exemptions & refunds. If people get a refund they are NOT paying the same share of their income, but even so, it is a plan I could support.

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