Tax Reform – Another Proposal

Fixing the Economy: The Common Sense Tax by Laurence Kotlikoff

Laurence Jacob Kotlikoff is a William Warren FairField Professor at Boston University, a Professor of Economics at Boston University, a Fellow of the American Academy of Arts and Sciences, a Research Associate of the National Bureau of Economic Research, a Fellow of the Econometric Society, a former Senior Economist, President’s Council of Economic Advisers, and President of Economic Security Planning, Inc.

America desperately needs tax reform. Our tax system is unfair, distortionary, wasteful, and a user’s nightmare. Most important, it’s limiting our country’s economic potential. I, like other academic public finance economists, have thought long and hard about how best to fix taxes. Last year, at, I proposed a system of low-rate consumption, payroll, and inheritance taxation, which would be a major advance over what we’ve got. It would also be remarkably progressive. The reason is that raising prices, as consumption taxes do, reduces the purchasing power of existing wealth and hits the rich with what amounts to wealth tax.

Unfortunately, convincing the public that taxing consumption is a progressive move is nigh impossible. Consequently, I’ve shifted gears to design an extremely simple and fairer version of our current income-based tax system. It’s called the Common Sense Tax and features just two taxes. One is a payroll tax that taxes all labor earnings at a flat 13 percent tax rate. The other is a personal income tax with a 25 percent tax on all household income above $100,000, in the case of married households, and $50,000, in the case of singles.

The reform, which is designed to be revenue neutral, would eliminate annual tax filing for over two thirds of American households and kick start our ailing economy. The Common Sense Tax is also designed to me progressive, if not more progressive than they current system.

An interesting concept that should please the ‘Flat Tax’ proponents while stimulating the economy by eliminating the corporate income tax.

The revenue that should be available from corporate taxes (but isn’t because of ‘cronyism’ and tax loopholes for corporations) is re-instated as a tax source by being taxed as personal earnings.  Capital gains are taxed as they accrue rather than being circumvented.

How is this accomplished?  Really rather simply.  Corporations are required to distribute at least 25% of their profits (regardless of source, i.e. local sales, foreign sales, or sale of assets) as dividends.  These dividends are then taxed as personal income by the recipient (stock holder) if they fall into the taxed income level ($50,000 individual, $100,000 married household).  Handling corporate profits this way is very similar to how unincorporated small business, and partnerships are currently taxed.

The actual mechanics of this ‘required’ dividend is not stated.  Would the corporation be allowed to determine the timing?  What might be the consequences, especially for those companies who do not currently pay dividends?  Unintended consequences?

This proposal does have a couple of wrinkles that may be hard for people to swallow.

First it eliminates all deductions except for three, the charitable deduction, the Child Tax Credit, and the Earned Income Tax Credit.

Second, the value of ‘perks’ (insurance, pension, etc.) become ‘wages’.  This will increase the tax base of ‘wages’ significantly and people earning less than $50,000 excluding those perks will suddenly find themselves in paying taxes on those credits exceeding $50,000.

The key elements as I see them:

  1. Eliminates the corporate income tax.  A highly desirable goal which eliminates the talk about ‘corporate loopholes’ and encourages competition by eliminating some of the onerous tax regulations that tend to favor existing corporations.
  2. Eliminates capital gains and the controversy about how these gains should be taxed.  This effectively eliminates the ability of the wealthy and ultra wealthy to avoid taxes.
  3. Eliminates the FICA and Medicare taxes on individuals.  These taxes are not eliminated just transferred from the employee to the employer.  The big change is that the tax is imposed on all income with no upper limit as there is now.  This is a move desired by most Democrats.  This is the only tax paid directly by corporations and shouldn’t be much of a burden since they already pay 1/2 of the tax for their employees.  It is proposed that the tax rate would be lowered.  As I see it this extends these entitlement programs but doesn’t solve the long term solvency problem.

Some potential negatives:

  1. May encourage ‘underground’ transactions (cash wages to avoid taxation).
  2. No impact on ‘illegal’ activities.  Drugs and other illegal activities avoid taxes.
  3. There is an implicit disincentive to earn more than the minimum and a significant ‘cliff’ when earning exceed that minimum.
  4. No impact on the multitude of ‘welfare’ programs.
  5. The total tax burden is placed on an even smaller number of people.  As the tax base gets smaller the system becomes more susceptible to ‘lobbying’ and corruption.


This proposal certainly deserves more consideration.  An article in The Fiscal Times, A Tax Reform Plan that Both Parties Can Like

A Tax Reform Plan that Both Parties Can Like
the charitable deduction, the Child Tax Credit, and the Earned Income Tax Credit. – See more at: charitable deduction, the Child Tax Credit, and the Earned Income Tax Credit. – See more at:
the charitable deduction, the Child Tax Credit, and the Earned Income Tax Credit. – See more at:
the charitable deduction, the Child Tax Credit, and the Earned Income Tax Credit. – See more at:

may be of interest.

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