Broad, Flat and Simple

If we are to get our country back on track I believe it is critical to reform our tax system.  I speak with some experience having practiced as both a CPA and tax attorney.  I have prepared and reviewed hundreds of tax returns.  It is time to tear the current system out by its roots and take a completely new look at the tax landscape.

On the individual income tax system we should be making the tax base as broad as possible by eliminating as many deductions, credits, preferences, exclusions and exemptions as we can.  The rate structure should also be as flat as possible to eliminate the cross currents of class warfare that divide us.  It should also be as flat as possible to provide as much incentive for future work, investment and capital formation.  Finally, it should be simple enough that anyone can comply with the tax law without an accounting or law degree.

There were 145 million tax returns filed last year.  More than 3/4 of all returns are now filed electronically.  However, almost 2/3 of those returns are prepared and filed by tax preparers.  Our tax system should not be so complex that taxpayers need to pay someone else to properly file their tax returns.  It also should not have to be necessary for most everyone else to need a computer program to file their taxes to have any chance of filing correctly.

All of this complexity is not needed to raise revenue.  It is only necessary for government to have the power to legislate, regulate and stipulate what its citizens should and should not do.  Picking winners and losers. Redistributing income.  Promoting and protecting special interests rather than promoting the public interest.  You don't need a massive and complex tax system to protect, defend and serve the general welfare.  You do need one to manage, control and serve special interests.

Therefore, if we are to turn America around then the critical first turn of the wheel must come in reforming the tax system.

The current individual income tax system generated $1.1 trillion in the last fiscal year.  The most recent IRS Statistics of Income data is from 2009.  In that year, total adjusted gross income was almost $8 trillion.  The exclusion for employer-paid health care amounts to another $1 trillion.  When all is said and done, we have a individual total income tax base (adjusting the numbers forward to 2011) that is around $10 trillion.  However, after subtracting for the exemptions, exclusions and deductions in the Internal Revenue Code, what is considered to be taxable income is only around $5 trillion.   Almost half of the tax base is being dissipated through special provisions in the law that favor one group or another.  This means that the potential exists to cut tax rates in half if the tax base was broadened.

A good starting point in discussing tax reform would be to start with the underlying principle that our tax system should be used to raise revenue.  It should not be a tool for supporting and promoting Big Government policies and philosophies.

If I was designing a starting point for reform, I would suggest a flat tax rate of 15% or lower. It would apply to all income.  No special rates for capital gains, dividends or carried interest.  I would provide an exemption on the first $10,000 for every adult.  This is approximately the federal poverty level for a single person.  I would also provide an additional $5,000 for every dependent child and for citizens 65 years of age or older.    I would eliminate all other exemptions, deductions, credits and exclusions except for retirement savings.  No mortgage interest, charitable contributions, state and local taxes or medical deductions.  There should be no sacred cows.

How does this play out for someone concerned that our tax system needs to be progressive to be "fair"? The substantial tax exemption provides progressivity in the effective tax rates as shown below.  This assumes a 15% flat tax rate.

Family of Four                     15% Tax                   Effective Tax Rate
Income


$20,000                                     $0                                  0%

$40,000                                   $3,000                            7.5%                        

$60,000                                   $6,000                            10%

$80,000                                   $9,000                            11.2%

$100,000                                 $12,000                          12%

$250,000                                 $34,500                          13.8%                      

$500,000                                 $72,000                           14.4%

$1,000,000                               $147,000                        14.7%

If this is still not considered progressive enough there are two options to remedy it.  You can increase the exemption amount which would also require an increase in the overall tax rate.  This would lower the effective rate at lower incomes.  Or you can move to a split rate.  For example, 15% on income below $100,000 (pick your number) and, say, 20% on income above $100,000. This would increase effective rates at higher incomes.  These are not ideal tax models but either approach would still be vastly superior to the tax system we have now.

Reforming the tax system is the foundational issue which must be won if the restoration of America is to be successful.  It should be the centerpiece of any Republican platform in 2012 and its legislative strategy for dealing with the impending expiration of the Bush (and Obama!) tax cuts at the end of this year.  Making taxes simpler has enormous political appeal and that should be the primary mantra of Republicans on this issue.  Herman Cain almost single-handedly propelled his campaign forward on one issue-his 9-9-9 tax platform.

I believe we are entering an era in which simple trumps complex, broad public interest defeats narrow special interests, and united beats divided. Now is the time to go broad, flat and simple in our tax policy as it is on the right side of the three major popular political trends I see in our future.