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Just about no one enjoys paying taxes, and if you’re reading this article, chances are you think you’re paying too much. But regardless of how you feel about tax rates, there’s one thing everyone can agree upon: our tax code is needlessly complicated.
Have you read the U.S. federal tax code? No, you haven’t–because the tax code is over 73,000 pages long. If the Constitution that has guided this republic for over 200 years can be easily read in one sitting, why is the tax code too complicated for even the hundreds of thousands of tax lawyers in America to ever comprehend?
Because of our massive–and growing–debt, reforming and modernizing the tax code will be political priorities for the next decade, so it’s important for citizens to understand what each of the proposals for tax reform truly mean. In this tip sheet, we’ll break down some of the most popular tax reform plans:
Let’s start with the status quo–the federal government has used a progressive taxation system for nearly a century. The term “progressive” in this type of tax has a double meaning. It creates a system of tax brackets according to personal income, and tax rates are progressively higher for each bracket, meaning someone earning $100,000 will surrender a higher percentage of their paycheck each month than someone earning $50,000.
“Progressive” also refers to the ideology of the early-20th century politicians who devised this tax. Theodore Roosevelt, Woodrow Wilson, and others believed society could “progress” through greater government involvement, and needed to hike taxes through this system to pay for their expensive programs.
Today, keeping all 73,954 pages of current progressive tax is an option, and some politicians would like to make it even more “progressive” by further raising taxes on high earners, and increasing tax credits and other handouts for low earners. An example of a radial progressive tax reform was Huey Long’s “Share Our Wealth” system, which began with the assumption that no one was entitled to any more than $1 million, and thus taxed all assets over $1 million at 100%.
The idea behind the “flat tax” is the opposite of the progressive tax–one tax rate for everyone. A true flat tax would eliminate all deductions, exemptions, write-offs, and the like, and tax all earners at a flat percentage of their income.
There are also modified versions of the flat tax, including one that would keep some deductions, aimed at helping low-income earners keep more of their money. Once all deductions are exhausted, a person’s remaining income would be taxed at a flat rate, no matter how much income he or she had. Another version of the flat tax takes the opposite route: taxing all income up to a certain level at a flat rate, and then taxing income over that level at a single, higher rate.
Milton Friedman, the famous free-market economist, once proposed a flat tax that not only would have reformed our tax code–it would have replaced large parts of the welfare state! This plan, called the “neutral income tax”, would tax everyone at the same rate and include large deductions (think $20,000 or more). If your deductions are higher than the amount of tax you owe, you receive a check from the government for the difference–a check that could replace welfare and other social services.
While the flat tax focuses on changing rates, the fair tax would blow up the tax code and start from scratch by replacing all federal taxes with a single tax on consumption–in other words, a sales tax.
Gone would be the federal income tax, corporate and capital gains taxes, payroll taxes (Social Security and Medicare), and even the death tax. In their place would be a national sales tax in the range of 23%, which would fund virtually all federal spending. This sales tax would be in addition to state sales taxes, and state and local government would continue to collect taxes through conventional methods.
Proponents of the fair tax argue that taxing consumption is the most judicious way to wrangle up enough tax money to keep the government operating. It gives poor people, who purchase fewer of the high-priced luxury goods (think cars, electronics, furniture, etc.) that will be the fair tax’s bread-and-butter, a break, while being less punitive than the progressive tax to high-income earners. Most versions of the fair tax include a system of deductions, credits, and exemptions designed at helping taxpayers purchase essentials like food without paying the national sales tax.
Opponents of this tax argue that it would hurt small businesses by discouraging personal spending, as a high national sales tax could cause citizens to think twice before buying even if they’re keeping their entire paychecks instead of sending large portions to the government. Naturally, this would lead to increased frugality and saving–not necessarily a bad outcome. But is this worth the risk to retailers and other small businesses?
Herman Cain’s famous tax solution combines elements of the flat tax and fair tax. As anyone who watched the Republican Party’s presidential debates in the fall of 2011 knows, 9-9-9 establishes three taxes that would replace all other taxes: a 9% national income tax, a 9% business transaction tax, and a 9% national sales tax.
At its core, 9-9-9 extracts money from citizens in three stages: first when they open their paycheck (9% is withheld), then when they purchase goods and services (the 9% sales tax), and finally when businesses close their books at the end of the day (9% of sales, minus costs, is taxed). The “fairness” of the fair tax is preserved, although at a lower rate, which could assuage the concerns of retailers and other small business owners. The flat 9% income tax also allows citizens to keep significantly more of each paycheck than they do under the current system.
When Cain first presented the plan, his political opponents argued that 9-9-9 wouldn’t produce enough revenue to keep the government going. The plan relies on economic growth and increased commercial activity to raise revenue–not all that dissimilar from “Reaganomics”, which Republicans originally derided just as Cain’s opponents attacked 9-9-9.
The other concern about this plan is that the 9% rates are not locked in, and can be changed by Congress at any time. Which means 9-9-9 could become 12-12-12 or 16-16-16 as fast as you can say fiscal cliff–and that’s an outcome no one wants to see.
Are you a proponent of states’ rights? Is your favorite amendment the 10th? Do you like aspects of several different plans to reform the tax code, and want to see the government experiment with each?
If yes, you may love the neutral tax. This plan shifts the taxation burden entirely to the states, with the federal government collecting a percentage of each state’s tax revenue to pay its bills. Under the neutral tax, you would pay taxes only to your state and local governments (albeit at higher rates), and those governments would in turn pay taxes to Uncle Sam.
The neutral tax gives states incredible freedom. As they replace the federal government as the primary tax collectors, states will be free to experiment with whatever sort of tax structure they like. For example, you could see some states enact the flat tax, others opt for the fair tax or 9-9-9, others keep a progressive tax, and others tinker with their tax code to incentivize business growth. No matter how a state taxes, it will need to generate enough revenue to both pay its own bills and send the federal government a check.
The neutral tax thus eliminates the IRS (it would be replaced by 50 state-level tax collection agencies), and get Congress and the White House out of tax policy, handing over that responsibility to state legislators and governors. This, in turn, gives citizens more control over how their tax rates are set–it’s easier to get your voice heard in your state capital than in Congress! It also allows states to work as “laboratories of democracy” by testing out different types of tax reform to see what works.
Opponents of the neutral tax argue that it’s change for the sake of change–there will still be a wide variety of taxes, they’ll just be collected by a different government. Others are concerned about the burden this places on state governments and the disparity this could create between states, arguing that the federal government is in better position to collect the nation’s taxes.
There are dozens of other ideas on how to clarify our 73,000 page tax code, and make tax collection more efficient and transparent. Part of being a citizen journalist is serving as an “information activist”: letting your fellow citizens know about what ideas are out there and how these ideas could affect their lives. With Tax Day just around the corner, there’s never been a better time to learn about our options for reforming taxation, and start a national conversation about making April 15 just a little less painful.
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