Comparison of Tax Reform Proposals

Just for kicks let’s compare the 4 tax reform proposals:

  1. Fix the existing tax code (The apparent approach of the current House Study Group)
  2. The Flat Tax  (The 15% tax on all income, personal and corporate)
  3. The Fair Tax (25% Sales tax to eliminate income tax, both personal and corporate)
  4. The Common Sense Tax (25% on personal earnings of $100,000 [married joint] and $50,000 [single]

Fix the existing tax code

  • The primary goal is to remove corporate loopholes and possibly lower the corporate rate to 25% which is close to the rest of the world.
  • Politically attractive since it has little impact on politicians ability to use the tax code to curry favor and does little to curb their power for social engineering via the tax code.
  • Perpetuates and may even strengthen the power of the IRS.
  • Little on no stimulus to the economy since the corporate tax is still equal to or higher than most of the world competition.

In my opinion this effort is a waste of time.

Flat Tax

  1. Much simpler for both corporate and personal use.
  2. Questions remain on treatment of ‘unearned income’ (capital gains, dividends, interest)  Many consider capital gain and dividend taxes to be a form of ‘double taxation’ and will fight to keep them at a lower rate.
  3. To achieve ‘neutrality’ of revenue, everyone earning an income would have to pay the tax to achieve a 15% rate.  (This will not go over well with ‘progressives’ who are determined to have ‘progressivity’ in the tax code.  My guess is that most Americans would agree with them.)
  4. Perpetuates the IRS even though simpler for the tax payer the IRS is still needed to audit and administer the new code.

Probably impossible to get consensus of both parties

Fair Tax

  1. Eliminates the tax on income and replaces it with a tax on consumption.  Will encourage savings and working.
  2. Eliminates the corporate tax making the U.S. highly competitive.  Will spur business growth in America creating jobs.
  3. Eliminates the separation of entitlement taxes (F’ICA and Medicare) from general tax revenue.  Should make it harder for politicians to ignore the impact of entitlement spending and stimulate reform.
  4. Unattractive to politicians since it virtually eliminates their ability to social engineer or favor anyone via the tax code.
  5. Eliminates the IRS.

My favorite but probably impossible to implement (see 4. above)

Common Sense Tax

  1. Eliminates the tax on corporate income by taxing that income as personal income.  Any reform that eliminates the corporate income tax will stimulate the economy and create jobs.
  2. Eliminates capital gains and thus the controversy over how those gains should be taxed.
  3. Transfers the FICA and Medicare tax from the individual to the business paying wages.  This does not impact the revenue from these taxes but it would add costs to the business in the short run, until they were able to adjust wages to reflect the change.
  4. Increases the wages being taxed by removing the upper limit.  Short term this allows the tax rate to be lowered for FICA and Medicare, but it will have to be increased as entitlement spending explodes in the future.  Note that the stimulated economy may allow the existing entitlement program to be viable for an extended period.
  5. Should reduce the IRS, but will not eliminate it.
  6. Very progressive with almost 2/3’s of households being below the taxable level of income.  This may be politically popular, but it is also a danger.  As the tax base becomes smaller (in number) the potential for that tax base to influence politicians becomes greater.

This could very possibly be accepted

  • It would appeal to most Americans
  • It perpetuates ‘class warfare’
  • A large percentage of the population would escape taxes
  • It preserves the existing entitlement program (at least in the short term)

My biggest concern with the Common Sense Tax proposal:  It puts the whole burden of government on less than 1/3 of the households and may lead to those households having undue influence on the government.  At the same time it totally removes the cost of government from the remaining 2/3’s encouraging them to demand more services and benefits from government.  This is a recipe for disaster and only exacerbates an existing problem where half the population pays taxes and the other half demands more.

The cost of government must be shared by everyone.  That is a key reason I prefer the Fair Tax, but it just might be possible to modify the Common Sense Tax to achieve a similar result.  Unfortunately that modification will undoubtedly make it harder to implement.

Here’s my thought.

If ‘everyone’ were taxed the rate could be reduced to 12% from 25%.  If we allow a standard deduction of $10,000 for anyone over 21 and $4,000 for every child, but tax all earnings over those deductions while maintaining the three deductions allowed by the Common Sense Tax, the rate would be something above 12% but considerably less than 25%.  Note:  The standard deduction could be set at any amount to yield revenue neutrality at a given rate.  Essentially the Common Sense Tax has applied a personal exemption of $50,000 to yield a 25% rate.  I think the rate should be 15% and would allow a much lower personal exemption to ‘broaden the base’ and get more people involved with the cost of government.

This just might be salable.  By preserving the entitlement programs it removes one big stumbling block.  There is general agreement that the corporate tax is too high but eliminating it would be a hard sell.  To help with selling the idea that profits, even those earned abroad, would be recovered via the personal tax on those profits should be stressed.  It should also be stressed that the ‘wealthy’ will be deprived of their ability to ‘manage’ capital gains.  Any gains will be taxed as profits via the personal tax.  This proposal eliminates all of the tax dodges used by the ‘wealthy’ and as such should appeal to Democrats.

If we can sell any tax reform that eliminates the income tax on corporations we will see a dramatic expansion of the economy and the creation of jobs.  This won’t solve our fiscal dilemma but it would be a great start!

I’m still concerned that there may be corruption in determining ‘profits’.  As long as our tax system is based on ‘income’ we will be constantly manipulating what counts as legitimate expense.  This will only be solved by switching our tax base from ‘income’ to ‘consumption’ and eliminating the definition of ‘profit’.  I’m still a supporter and advocate for the Fair Tax!   I don’t know how to sell the Fair Tax to the masses and could accept the Common Sense Tax (as modified) as an interim step.  I think the problems I’ve mentioned would lead to its demise, and if they didn’t arise I’d have no problem accepting it as a satisfactory tax system.

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