Principles
My plan is based on two principles:
- Let the sunshine in. Voters and policy makers need to understand what's being paid, by whom, and why. Let's minimize the extent to which the taxes that other people pay trickle down to us in ways we can't see. Let's also minimize the extent to which the government incentivizes (or not) specific behaviors within the tax code.
- Everybody pays, nobody quits. We fought a revolution based on the principle of "no taxation without representation". Folks, I'm here to say that it works the other way 'round as well. The tax base is more stable when it's wide, and everyone's more invested when everyone invests. This principle applies to both the folks at the bottom as well as to folks at the top.
Under my plan, taxes are paid on the basis of a household. The tax man does not need to know which of the people in it are earners and which dependent, whether dependents are adults or children, whether earners are married to one another, or any other such extraneous details.
1. Calculate the household's gross income by piling together all the income earned by the members of the household. This includes income from all sources: wages and salaries, investment interest, dividends, and realized capital gains. If you own something, and you sell it for a profit, that's income. It makes no difference whether the thing you sell is your labor, your boat, your stake in an investment, or anything else. This is a big change from today's tax system, in which investment income is taxed at a flat low rate separate from other income. Note that unrealized capital gains are not income and therefore are not taxed.
(A capital gains example, for those who aren't quite sure what capital gains are: Suppose you own stock, and today someone tells you, "I would pay you $100 for that." Tomorrow they tell you "I would pay you $110." My friend, you have just had an unrealized capital gain of $10. This may make you feel good, but you don't actually have any more money than you did before, do you? It's all hypothetical. So you sell your stock -- suppose you really do get $110 for it. At that point, you have realized your capital gain, and the $10 goes into the pile as taxable income.)
2. Calculate the household's gross taxable income by deducting anything you gave away or that will immediately appear on someone else's income tax return. Translation: subtract any charitable donations and any wages paid to employees. The latter obviously won't impact many individuals, but it will impact corporations -- see below. The purpose is to minimize friction and to expose individual citizens to the true amount of taxation they're subject to. If your boss has $100K to spend on payroll, pays 20% to the government, pays the remainder to you, and then you pay 20% to the government, you haven't been taxed 20%; you've effectively been taxed 36%.
3. Pay a flat portion of your taxes on your gross taxable income.
- This includes today's so-called "payroll tax", consisting of Social Security and Medicare tax, which is assessed on your gross already today. I make two changes to this tax: first, there is no cap. High earners should pay the same percentage as low earners -- today they pay less. Second, the employer portion of this tax is eliminated and shifted to the employee -- see below for details. The employee feels the full impact of both portions of this tax already today, so she should see that impact explicitly on her pay stub.
- I also add a flat income tax component of 1%. This amount is small, but it gets everyone into the system.
(A comparison with today's standard deduction: A single person gets about $5,400, a married couple $10,700, and a "head of household" about $7,900. A dependent is worth $3,700 plus an extra grand if it's a kid. Yes, it's complicated. The net is that a couple with two kids will deduct $20,100 under today's tax code and $22,000 under mine. The standard deduction for single parents of two children will be much higher under my plan than it is today. The deduction for married couples with five or more children will be lower. My plan is more generous in this regard for most households to compensate for the fact that it adds the 1% flat tax above and removes the Earned Income Tax Credit as well as other credits and deductions.)
5. Pay marginal taxes on your net taxable income. To get the marginal rates, first look to today's tax brackets. Under my plan, the 10% bracket falls to 8%, the 15% bracket to 12%, the 25% to 20%, and the 28% to 25%. The higher brackets are eliminated. People who pay most of their taxes in lower brackets should see a rate cut, although a small one -- remember they already paid 1% on their gross taxable income. The very wealthy will see a big cut in the rate they pay on wage income, but a bigger increase in the rate they pay on investment income -- as much as 25% vs. a flat 15% today. In addition, many itemized deductions, such as mortgage interest, will go away. See below.
That's it. There are no further deductions or exemptions or credits or caveats. You could write a tax form for this system on one side of one sheet of paper.
How It Works for Corporations
Corporate taxes are based on the same system outlined above for households. Income paid out in salaries is not taxed. Dividing the net taxable income by the number of employees will give you the tax brackets to use.
Calculating a precise number of employees gets more difficult as companies get larger, because the number is constantly changing. We can make things simple by using the final head count as of the end of the previous year.
Note that unlike today, corporations will pay no payroll tax under my plan -- the full burden of that tax falls to the employees. Therefore, when we roll out my plan (and why wouldn't we; it's eminently reasonable), we will have to set up a system whereby initially the money the company would have paid in payroll taxes gets shifted into actual payroll such that the net cost to employers and employees doesn't change dramatically. I'm not going to try to solve that problem here.
Further Words on a Couple of Big Deductions That Are Going Away
I want to say a couple of things about two popular deductions that I would eliminate.
1. Mortgage interest. A subsidy that is available to everyone who purchases a certain product doesn't make that product more affordable; it makes it more expensive. It inflates demand by increasing every buyer's purchasing power. Translation: the value of this deduction is already included in the sticker price you paid for your house. This deduction encourages people who do buy houses to take out bigger loans, and it penalizes people who don't own homes (e.g. poor people) at tax time. We need to get rid of it.
At the same time, precipitously slashing this deduction to zero would potentially increase the tax burden on some middle- and upper-income households by many thousands of dollars, and it would drop home values by 10-20%. Therefore, I propose we phase this change in over a decade.
Every mortgage's deductibility will be frozen at the time the mortgage is issued; no one's deduction will decrease or go away. Furthermore, for new mortgages, the deduction will erode gradually at a rate of 20% every two years: For the first two years after my tax plan is adopted, there will be no change to this deduction. This means homes already on the market will not be affected, and people who want to move or refinance will have an opportunity to do so. During the following two years, interest payments on new mortgages will be 80% deductible. Then 60%, 40%, etc. until the deductibility falls to zero at the ten-year mark.
2. Health insurance. Currently, employers who offer health insurance to their employees can deduct the cost of this benefit from their taxes. Remember what I said above about subsidies to everyone being inflationary? Subsidies to almost everyone are worse: they're still inflationary, but they actively penalize those few who are left out. Most people get health insurance from their employers; some don't. The result is that those who want to purchase on the individual market effectively pay a very significant markup, not even including the loss of group rates.
Getting health care costs under control will require those costs to be fair, transparent, and accessible. That means getting rid of this deduction, along with a number of other changes in health care regulation. Those other changes are topics for other posts.
Who's With Me?
Let's sum up:
- People at the very bottom, who today pay little or no income tax, will pay something -- maybe a couple hundred bucks a year.
- People in the middle will see their taxes stay about the same. Those who use the standard deduction are likely to get a slight cut. Those who also give heavily to charity will see a bigger cut. Those who today save heavily from itemized non-charitable deductions may pay slightly more.
- Affluent people who work for their money will get a nice rate cut, though they will pay more into Social Security and Medicare and will lose most deductions.
- Very affluent people who live off of their investments will finally have to pay tax rates that are at least no lower than those paid by their personal assistants.
- Dozens of loopholes will be closed, and the tax system will become dramatically simpler and easier to understand.
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