Recommendations to the President's Advisory Panel on Federal Tax Reform
Executive Summary
We propose a two-pronged approach to tax reform. The first prong is an indirect business income tax replacing revenue currently collected by the personal income tax at the 25% tax rate and below, including the 25% portion of the higher tax rates (for example, the first 25% of the 33% rate); all revenue from Disability Insurance, the portion of survivors insurance which funds the dependents of non-retired workers, and Health Insurance (Medicare) contributions; and all revenue from the current business income tax. This proposal shifts the tax liability for labor from individuals to their employers, ending its deductibility as a business income tax expense. Material costs and purchased services will be excluded. Certain deductions will also be transferred to the employer, although the funds will be passed to the employee. The chief among these is a consolidated child and dependent credit. Other deductions include health insurance, charitable contributions as designated by the employees and home mortgage interest. Inclusion of these credits and deductions make passage more likely.
The second prong is a surtax on individual income from all sources (labor, inheritance and capital) over $100,000 per year at rates between 3% to 10% to between 6% and 14.9%. Only the proceeds from the sale of inherited assets or inherited cash are taxed. Working assets are not. Exclusions include credits given to the employee under the business income tax, spousal income under $100,000, interest on federal and municipal bonds and proceeds from the sale of stocks to an ESOP. Transfers to charities and trusts are not tax exempt.
This proposal contains the required progressive component, which makes it fairer than a flat or consumption tax. Economic studies by the Center also indicate that this progressivity will also spur economic growth. Finally, transition is eased because collection flows are not drastically altered under this proposal.
I. Description of Proposal.
A. Business Income Tax
1. Tax Base and 8. Treatment of Businesses
The tax base for the business income tax will be all value added by the business in terms of both labor and profit. In other words, it will be all revenue of the firm less material costs and purchased services. All wages paid to workers in the United States will be subject to tax, as well as all profits from domestic sales and exports. While this tax is clearly an income tax, it has features of a consumption task, as does most of the current income tax. Consumers who are familiar with the tax system know that a significant percentage of the purchase price of the goods and services they consume are the income and payroll taxes of the employees providing these goods and services.
An essential feature of this reform would be to decrease gross, but not net, wages by the amount that was formerly withheld for payroll and income taxes (except for the spread between the 25% rate and the upper rates for high income taxpayers, which would still be withheld).
2. Exemptions, deductions, credits and exclusions
To protect small home-based businesses from onerous reporting burdens, operations with total revenue under $15,000 per year would be exempt from taxation.
All material and purchased services costs are deductible, with these amounts reported with a Form 1099 to the vendor and to the IRS. Facilities and equipment costs continue to be deductible, but such deductibility reflects the technologically useful life of the asset, with accelerated deduction of those assets that become obsolete quickly.
The chief credit is a $6,000 credit for each child, dependent spouse or dependent senior, which is paid directly to the employee, regardless of wage level. It is most likely matched by a similar state level credit, whose size depends on the cost of living in each state.
A variety of popular deductions also continue. A home mortgage deduction and a religious contribution credit are to be included, as described below. A deduction for health care costs and insurance is also included. To the extent that the employer does not provide health insurance, a tax credit is passed on to employees on a monthly basis to pay for the costs of basic health care coverage. This credit is adjusted to various people’s circumstances, so that lower cost individuals receive less of a credit than higher-cost families. Senator Robert Dole first proposed such a credit in 1993. It is time to fulfill this promise.
A credit is also be created for firms who carry disability and retiree health insurance for all of their former employees who have become disabled or retired, as long as the benefits provided are as generous as those provided by the Government. This credit would offset the disability and health insurance contributions currently required under FICA for both employers and employees provided that alternate coverage is purchased for at least that amount.
Firms would receive a credit for employee education and training, ranging from remedial education to college tuition. Both the high tech and nursing skill shortages and the crisis in basic literacy can be overcome with this tool. Combined with the dependent tax credit described above, this new tool moves people from dependency to work at their full potential, especially if combined with other workforce development programs. This credit is structured to give firms the incentive to hire, train and pay individuals in vocational training programs, the last two years of college, graduate school or recipients of Temporary Aid to Needy Families and other anti-poverty programs. This credit will be offset on the spending side of state and federal budgets by matching cuts in education and workforce development programs.
Ideally, there are no other deductions. Industry specific deductions and credits are abolished, or at least capped at 2% of total value-added. Shelters that hide profits offshore will be eliminated. If a product is both produced and consumed domestically, all resulting profits are fully taxed. Profits realized on financial holdings are also taxed if the beneficiaries are U.S. residents, regardless of where production occurred.
3. Tax rate(s)
Before adjustments reflecting the spending side of the budget, the tax rate before deductions would be set at approximately 45.69% of net (after tax) wages and profits or 33.1% of total value added (including taxes). This corresponds to adding the 25% personal income tax rate, the 3% unemployment tax rate (on average) and the 5.1% rate for social insurance taxes. Note that this is the rate before credits and deductions. After these are included in the calculation the effective tax rate is likely to be much less, likely averaging around 18% of value added. These rates should not increase with the sunset of the current tax cuts.
Ideally, the Business Income Tax would raise adequate revenue to fund domestic discretionary, non-retirement entitlement and domestically based defense spending, less revenue from fees, excise taxes and a portion of tariff revenues. It would not fund overseas military operations, net interest, the redemption of the Social Security trust fund, transition costs for personal retirement accounts or the eventual retirement of the national debt, all of which would be funded by personal income surtaxes on individual incomes over $100,000 (see B below). Our retirement insurance recommendations were provided to the President’s Commission to Save Social Security and to various congressional committees. They are not repeated here.
More detailed estimates are not available from the Iowa Center for Fiscal Equity at this time, as we lack the data to adequately estimate what the tax rate would be for various sectors of the economy. We suggest using the Joint Tax Committee and the Internal Revenue Service to generate a more detailed estimate for the Panel’s final recommendation should these proposals be adopted (in which case we would gladly participate in these more detailed analyses).
4. Distribution of the tax burden (including provisions for relief for low-income individuals)
This tax would be paid by all businesses, regardless of form of ownership, with gross revenues over $15,000. It would affect the wages and benefits of all employees in these firms. It would not be paid by federal employees, whose gross but not net wages would be decreased to compensate for the elimination of certain payroll and withholding taxes. A mandatory federal payment will be made to states in which federal employees reside and work (in the case of interstate commuters and including the District of Columbia) equal to the amount that these jurisdictions would otherwise receive in tax payments. Non-profit corporations, state governments and religious organizations would pay the business income tax on their net payroll.
Provision for lower-wage workers will be made through the expanded child tax credit. This credit is essentially a pro-life credit, as its intended effect is to decrease abortion and increase childbirth. Such a credit also reverses the aging of society. It removes the financial pressure from struggling families, especially young families, discourages divorce and rewards work at all wage levels. The size of the credit more than compensates for the loss of the 10% and 15% tax rates. This reform leads to a restructuring of wages in many companies. Most firms will establish a lower base wage for all workers, regardless of family status. Average size families making an average salary will likely feel no economic effect. Higher income earners with no dependent children will see some income loss, while lower income individuals with large families realize a net gain. The dynamic nature of these calculations also makes an estimate of a final tax rate impossible at this time.
5. Treatment of charitable giving
Firms will receive a credit for grants to charitable organizations as designated by their employees individually. Tuition for faith-based elementary and secondary schools may be included in this credit if it is adopted at the state and local level, in lieu of payment of state and local taxes for public education (although individuals supporting public education may designate their education charity contribution go to the public school system).
6. Treatment of home ownership
The home mortgage interest deduction is preserved as a credit paid to employees or as a deduction for employee-owned firms who offer low or no interest home loans to their employees. The popular home mortgage credit was spared tax reform in 1986. Homebuilders, mortgage bankers and homeowners fight any restructuring that does not provide for this credit to continue in some form. This approach to tax reform succeeds where straight consumption taxes and flat taxes fail to be anything but an academic exercise.
7. Collection method(s)
Taxes would be collected and reported quarterly in much the same way that small businesses file quarterly estimated taxes and employers currently submit payroll and withholding taxes for their employees. Employers will include in their tax filing a record of how the dependent tax credit was distributed and provide each employee with a copy of his or her dependent credit statement. The government then sends a form to each employee with instructions to compare the two statements and to notify the IRS of any disparity. If an employer under-pays the credit, the government reimburses the difference to the employee and seeks damages from the employer. To guard against exploitation of undocumented workers, no residency verification is included in this process.
B. Personal Income and Inheritance Taxes for Higher Earners
1. Tax Base and 2. Exemptions, Deductions, Credits and Exclusions
All individual income over $100,000 from wages, dividends, interest, inheritance and capital gains is subject to tax, with the exclusion Business Income Tax credits, interest on Treasury Bills, Municipal Bonds and proceeds from the sale of stock to a qualified ESOP. Taxes are only due on estate income when assets are liquidated, not upon inheritance. There are no other exemptions, credits, deductions or exclusions. No addition of spousal income will be made, so that spouses making under $100,000 will pay no surtax. Let us reiterate, combined income over $100,000 should not be subject to this surtax.
3. Tax Rate(s)
The surtax rate will be 3% for income between $100,000 and $146,750, 8% for those currently paying earning between $146,751 and $319,000 and 10% for all income above that level. After the current tax rate cuts sunset the rates will be 6% for the lowest bracket income, 11% for the middle bracket income and 14.6% for the highest bracket income. Failure to use these rates after 2010 violate the assumptions of revenue neutrality.
As stated previously, this tax and a portion of tariff revenues will ideally fund overseas military operations, net interest, redemption of the Social Security trust fund, transition costs for establishing personal retirement accounts and the eventual retirement of the national debt. When the transition to personal accounts is complete and the debt is retired, the surtax should sunset.
4. Distribution of the tax burden
This surtax will only be paid by higher income individuals making over $100,000.
5. Treatment of charitable giving
No provision is made for charitable giving as a way of excluding income for the surtax. Such giving to one’s own foundation or to one’s heirs is a notorious tax avoidance scheme which must be eliminated.
6. Treatment of home ownership - see A above
7. Collection method(s)
Employers will withhold the surtax from employees with salaries over $100,000, not including business income tax credits received through the employer. Surtaxes due on interest, dividend and capital gains income will be withheld by the issuer after a threshold established by the investor based on his or her income is reached. For example, lower income investors will not withhold any dividends or gains under $100,000, while higher income individuals might have surtaxes withheld on the first dollar of dividends or interest payments. Regardless, all wages, dividends, interest and capital gains or losses will be reported to the Internal Revenue Service much as they are today with the taxpayer filing an annual return.
8. Treatment of business
This surtax is only for individuals, not firms. Retaining the Personal Income Tax for higher incomes as a separate program allows higher income individuals to avoid sharing all of their personal economic information (including inheritance information) with both their employers and the firms in which they hold stock. Forcing businesses to be accountable for the alternative rather than individuals would produce a reporting nightmare for most firms and violate the privacy of employees and investors. In this instance, reporting this information to the government is better than disclosing it to the employer and is a better alternative to such a convoluted system.
II. Impact of Proposal Relative to Current System.
Simplicity is improved for the vast majority of individual taxpayers, who will no longer have to file any kind of tax reporting unless what is reported by the employer is different from what is reported to them. Sole proprietors will likely still face a complex tax form, although even their reporting will be simplified. Double reporting of the Child and Dependent credits and other credits paid to the employee make this part of the system transparent. While the amount of tax owed due to the employees’ labor is no longer transparent to the employee, this need not be a concern since they are no longer directly liable for these taxes. Much of the call for this type of transparency betrays a bias toward less government. In a time when so many items are under-funded, for example housing assistance and the War in Iraq, such a bias is parsimonious at best and treasonous at worst. These proposals are stable to the extent that the Business Income Tax is designed to fully cover domestic and CONUS military spending. Historically, such spending only changes incrementally, as will the tax expenditures included in the business income tax.
Failure to collect personal income surtaxes shifts the burden for collection of those monies taxed at a higher rate to lower-wage workers indirectly taxed by the business income tax. Such a shift will decrease aggregate demand, leading to recession or worse. There are two options for continuing to collect higher tax payments from wealthier individuals without slowing the economy: a surtax on the employer’s Business Income Tax for payments to higher income employers and shareholders or retention of the Personal Income Tax for these individuals.
Overall, economic growth and competitiveness will increase as lower income individuals receive a higher wage. The training provisions and the transfer of family support from the entitlement system to the tax system will decrease crime as it decreases poverty. The cycle of fatherlessness and crime in poor communities will be broken, yielding more productive workers and less drug dealers. Incentiving childbirth with this tax credit will make the U.S. more competitive by increasing the number of potential workers, lowering per capita retirement costs.
Retention of an income tax and progressivity have their own economic benefits. Economic data from the last 40 years shows that when Democrats cut the budget the economy grows, while Republicans only get growth by running a deficit. Statistical analysis shows that when the budget is reduced to its impact on the financial markets (deficit + net interest) and this figure is expressed as a percentage of economic growth, Democrats get more growth from cutting the deficit while Republicans get growth by increasing it. Only one factor, which is consistently different between Democratic and Republican regimes, explains this: tax policy. Democrats usually build a more progressive tax structure while Republicans lower taxes on the wealthy, making taxes more proportional. Economically, when you make taxes more progressive taxpayers who are more likely to consume have more money while taxpayers who are more likely to save have less. This spurs economic growth measures because economic growth measures are more closely tied to consumer spending than to saving.
If supply side economists wish to justify a stronger savings sector they need measures of economic health that have nothing to do with spending. However, their policies still fail due to the nature of most business investment. Most business investment models are based on marketing, meaning that demand for a new or existing product causes firms to put resources into plant and equipment to produce that product. If there is no demand for the product no investment is made (investment managers who recommends replacing equipment without demand solely because the cost of capital is low do not stay employed for long). Additionally, if there is higher aggregate demand, also known as economic growth, then it is more likely that an individual product catches on, leading to high return on investment in plant and equipment.
Compliance and administration costs will decrease as the number of direct taxpayers decrease. These costs will only increase marginally for employers, since they already must keep detailed employment and tax records on their employees. Small additional costs will be incurred in tracking the child and dependent tax credit, although these should not be dissimilar to the costs associated with reporting wages currently.
III. Transition, Tradeoffs and Special Issues.
As previously stated, the consolidation of a more robust child tax credit will serve as a disincentive to abortion and will be helpful in increasing the number of births, thus counteracting the aging of society. As such it will attract support from both the pro-life and living wage movements. The home building, mortgage and health care industries and state and local governments maintain their current advantages in these proposals. Failure to let them do so is like picking a fight with the school bully for no good reason. Unlike the consumption tax, the food, retail and restaurant sectors will not be overly burdened by these proposals, where a consumption tax will negatively impact these industries and invite retaliation. Other industries seeking special tax breaks that are not as well distributed to the entire population will not maintain these advantages under these proposals.
Transition concerns are less than with the inauguration of a consumption tax. The overwhelming majority of employers already collect payroll and income taxes from their employees’ paychecks. These proposals simply make the employer directly liable for these taxes rather than leaving ultimate responsibility with the employee. Employers will need to inaugurate systems to track and claim a few new deductions and credits. The vast majority of the transition costs will be with the IRS, who must rewrite instructions, pamphlets and software. However, in this day and age the entire process might become mostly paperless with tax filing becoming a part of the firm’s accounting system.
We have assumed that the Business Income Tax will be revenue neutral as a substitute for non-retirement payroll taxes, current business income taxes and for personal income taxes, credits and deductions at the 25% rate and below (including the first 25% of the 28%, 33% and 35% rates). We encourage adoption of a final rate which fully funds domestic non-retirement and CONUS military operations. In order to maintain revenue neutrality while the current tax rate cuts are in effect the surtax rates would be adjusted so that only the difference between current revenues and proceeds from the business income tax above. We assume that after 2010 the tax cuts on higher income workers will be allowed to sunset, which we believe is necessary for the health of the economy. Finally, we recommend sunsetting the personal income surtax upon the retirement of the entire public debt. This gives higher income taxpayers an incentive to support higher rates in order to see the surtax disappear.
Update: For interesting ideas along the same lines, see Dr. Carl Milsted's Holistic Politics for How to Tax Corporations and how to get people above the poverty line with a fuzzy cutoff.
We propose a two-pronged approach to tax reform. The first prong is an indirect business income tax replacing revenue currently collected by the personal income tax at the 25% tax rate and below, including the 25% portion of the higher tax rates (for example, the first 25% of the 33% rate); all revenue from Disability Insurance, the portion of survivors insurance which funds the dependents of non-retired workers, and Health Insurance (Medicare) contributions; and all revenue from the current business income tax. This proposal shifts the tax liability for labor from individuals to their employers, ending its deductibility as a business income tax expense. Material costs and purchased services will be excluded. Certain deductions will also be transferred to the employer, although the funds will be passed to the employee. The chief among these is a consolidated child and dependent credit. Other deductions include health insurance, charitable contributions as designated by the employees and home mortgage interest. Inclusion of these credits and deductions make passage more likely.
The second prong is a surtax on individual income from all sources (labor, inheritance and capital) over $100,000 per year at rates between 3% to 10% to between 6% and 14.9%. Only the proceeds from the sale of inherited assets or inherited cash are taxed. Working assets are not. Exclusions include credits given to the employee under the business income tax, spousal income under $100,000, interest on federal and municipal bonds and proceeds from the sale of stocks to an ESOP. Transfers to charities and trusts are not tax exempt.
This proposal contains the required progressive component, which makes it fairer than a flat or consumption tax. Economic studies by the Center also indicate that this progressivity will also spur economic growth. Finally, transition is eased because collection flows are not drastically altered under this proposal.
I. Description of Proposal.
A. Business Income Tax
1. Tax Base and 8. Treatment of Businesses
The tax base for the business income tax will be all value added by the business in terms of both labor and profit. In other words, it will be all revenue of the firm less material costs and purchased services. All wages paid to workers in the United States will be subject to tax, as well as all profits from domestic sales and exports. While this tax is clearly an income tax, it has features of a consumption task, as does most of the current income tax. Consumers who are familiar with the tax system know that a significant percentage of the purchase price of the goods and services they consume are the income and payroll taxes of the employees providing these goods and services.
An essential feature of this reform would be to decrease gross, but not net, wages by the amount that was formerly withheld for payroll and income taxes (except for the spread between the 25% rate and the upper rates for high income taxpayers, which would still be withheld).
2. Exemptions, deductions, credits and exclusions
To protect small home-based businesses from onerous reporting burdens, operations with total revenue under $15,000 per year would be exempt from taxation.
All material and purchased services costs are deductible, with these amounts reported with a Form 1099 to the vendor and to the IRS. Facilities and equipment costs continue to be deductible, but such deductibility reflects the technologically useful life of the asset, with accelerated deduction of those assets that become obsolete quickly.
The chief credit is a $6,000 credit for each child, dependent spouse or dependent senior, which is paid directly to the employee, regardless of wage level. It is most likely matched by a similar state level credit, whose size depends on the cost of living in each state.
A variety of popular deductions also continue. A home mortgage deduction and a religious contribution credit are to be included, as described below. A deduction for health care costs and insurance is also included. To the extent that the employer does not provide health insurance, a tax credit is passed on to employees on a monthly basis to pay for the costs of basic health care coverage. This credit is adjusted to various people’s circumstances, so that lower cost individuals receive less of a credit than higher-cost families. Senator Robert Dole first proposed such a credit in 1993. It is time to fulfill this promise.
A credit is also be created for firms who carry disability and retiree health insurance for all of their former employees who have become disabled or retired, as long as the benefits provided are as generous as those provided by the Government. This credit would offset the disability and health insurance contributions currently required under FICA for both employers and employees provided that alternate coverage is purchased for at least that amount.
Firms would receive a credit for employee education and training, ranging from remedial education to college tuition. Both the high tech and nursing skill shortages and the crisis in basic literacy can be overcome with this tool. Combined with the dependent tax credit described above, this new tool moves people from dependency to work at their full potential, especially if combined with other workforce development programs. This credit is structured to give firms the incentive to hire, train and pay individuals in vocational training programs, the last two years of college, graduate school or recipients of Temporary Aid to Needy Families and other anti-poverty programs. This credit will be offset on the spending side of state and federal budgets by matching cuts in education and workforce development programs.
Ideally, there are no other deductions. Industry specific deductions and credits are abolished, or at least capped at 2% of total value-added. Shelters that hide profits offshore will be eliminated. If a product is both produced and consumed domestically, all resulting profits are fully taxed. Profits realized on financial holdings are also taxed if the beneficiaries are U.S. residents, regardless of where production occurred.
3. Tax rate(s)
Before adjustments reflecting the spending side of the budget, the tax rate before deductions would be set at approximately 45.69% of net (after tax) wages and profits or 33.1% of total value added (including taxes). This corresponds to adding the 25% personal income tax rate, the 3% unemployment tax rate (on average) and the 5.1% rate for social insurance taxes. Note that this is the rate before credits and deductions. After these are included in the calculation the effective tax rate is likely to be much less, likely averaging around 18% of value added. These rates should not increase with the sunset of the current tax cuts.
Ideally, the Business Income Tax would raise adequate revenue to fund domestic discretionary, non-retirement entitlement and domestically based defense spending, less revenue from fees, excise taxes and a portion of tariff revenues. It would not fund overseas military operations, net interest, the redemption of the Social Security trust fund, transition costs for personal retirement accounts or the eventual retirement of the national debt, all of which would be funded by personal income surtaxes on individual incomes over $100,000 (see B below). Our retirement insurance recommendations were provided to the President’s Commission to Save Social Security and to various congressional committees. They are not repeated here.
More detailed estimates are not available from the Iowa Center for Fiscal Equity at this time, as we lack the data to adequately estimate what the tax rate would be for various sectors of the economy. We suggest using the Joint Tax Committee and the Internal Revenue Service to generate a more detailed estimate for the Panel’s final recommendation should these proposals be adopted (in which case we would gladly participate in these more detailed analyses).
4. Distribution of the tax burden (including provisions for relief for low-income individuals)
This tax would be paid by all businesses, regardless of form of ownership, with gross revenues over $15,000. It would affect the wages and benefits of all employees in these firms. It would not be paid by federal employees, whose gross but not net wages would be decreased to compensate for the elimination of certain payroll and withholding taxes. A mandatory federal payment will be made to states in which federal employees reside and work (in the case of interstate commuters and including the District of Columbia) equal to the amount that these jurisdictions would otherwise receive in tax payments. Non-profit corporations, state governments and religious organizations would pay the business income tax on their net payroll.
Provision for lower-wage workers will be made through the expanded child tax credit. This credit is essentially a pro-life credit, as its intended effect is to decrease abortion and increase childbirth. Such a credit also reverses the aging of society. It removes the financial pressure from struggling families, especially young families, discourages divorce and rewards work at all wage levels. The size of the credit more than compensates for the loss of the 10% and 15% tax rates. This reform leads to a restructuring of wages in many companies. Most firms will establish a lower base wage for all workers, regardless of family status. Average size families making an average salary will likely feel no economic effect. Higher income earners with no dependent children will see some income loss, while lower income individuals with large families realize a net gain. The dynamic nature of these calculations also makes an estimate of a final tax rate impossible at this time.
5. Treatment of charitable giving
Firms will receive a credit for grants to charitable organizations as designated by their employees individually. Tuition for faith-based elementary and secondary schools may be included in this credit if it is adopted at the state and local level, in lieu of payment of state and local taxes for public education (although individuals supporting public education may designate their education charity contribution go to the public school system).
6. Treatment of home ownership
The home mortgage interest deduction is preserved as a credit paid to employees or as a deduction for employee-owned firms who offer low or no interest home loans to their employees. The popular home mortgage credit was spared tax reform in 1986. Homebuilders, mortgage bankers and homeowners fight any restructuring that does not provide for this credit to continue in some form. This approach to tax reform succeeds where straight consumption taxes and flat taxes fail to be anything but an academic exercise.
7. Collection method(s)
Taxes would be collected and reported quarterly in much the same way that small businesses file quarterly estimated taxes and employers currently submit payroll and withholding taxes for their employees. Employers will include in their tax filing a record of how the dependent tax credit was distributed and provide each employee with a copy of his or her dependent credit statement. The government then sends a form to each employee with instructions to compare the two statements and to notify the IRS of any disparity. If an employer under-pays the credit, the government reimburses the difference to the employee and seeks damages from the employer. To guard against exploitation of undocumented workers, no residency verification is included in this process.
B. Personal Income and Inheritance Taxes for Higher Earners
1. Tax Base and 2. Exemptions, Deductions, Credits and Exclusions
All individual income over $100,000 from wages, dividends, interest, inheritance and capital gains is subject to tax, with the exclusion Business Income Tax credits, interest on Treasury Bills, Municipal Bonds and proceeds from the sale of stock to a qualified ESOP. Taxes are only due on estate income when assets are liquidated, not upon inheritance. There are no other exemptions, credits, deductions or exclusions. No addition of spousal income will be made, so that spouses making under $100,000 will pay no surtax. Let us reiterate, combined income over $100,000 should not be subject to this surtax.
3. Tax Rate(s)
The surtax rate will be 3% for income between $100,000 and $146,750, 8% for those currently paying earning between $146,751 and $319,000 and 10% for all income above that level. After the current tax rate cuts sunset the rates will be 6% for the lowest bracket income, 11% for the middle bracket income and 14.6% for the highest bracket income. Failure to use these rates after 2010 violate the assumptions of revenue neutrality.
As stated previously, this tax and a portion of tariff revenues will ideally fund overseas military operations, net interest, redemption of the Social Security trust fund, transition costs for establishing personal retirement accounts and the eventual retirement of the national debt. When the transition to personal accounts is complete and the debt is retired, the surtax should sunset.
4. Distribution of the tax burden
This surtax will only be paid by higher income individuals making over $100,000.
5. Treatment of charitable giving
No provision is made for charitable giving as a way of excluding income for the surtax. Such giving to one’s own foundation or to one’s heirs is a notorious tax avoidance scheme which must be eliminated.
6. Treatment of home ownership - see A above
7. Collection method(s)
Employers will withhold the surtax from employees with salaries over $100,000, not including business income tax credits received through the employer. Surtaxes due on interest, dividend and capital gains income will be withheld by the issuer after a threshold established by the investor based on his or her income is reached. For example, lower income investors will not withhold any dividends or gains under $100,000, while higher income individuals might have surtaxes withheld on the first dollar of dividends or interest payments. Regardless, all wages, dividends, interest and capital gains or losses will be reported to the Internal Revenue Service much as they are today with the taxpayer filing an annual return.
8. Treatment of business
This surtax is only for individuals, not firms. Retaining the Personal Income Tax for higher incomes as a separate program allows higher income individuals to avoid sharing all of their personal economic information (including inheritance information) with both their employers and the firms in which they hold stock. Forcing businesses to be accountable for the alternative rather than individuals would produce a reporting nightmare for most firms and violate the privacy of employees and investors. In this instance, reporting this information to the government is better than disclosing it to the employer and is a better alternative to such a convoluted system.
II. Impact of Proposal Relative to Current System.
Simplicity is improved for the vast majority of individual taxpayers, who will no longer have to file any kind of tax reporting unless what is reported by the employer is different from what is reported to them. Sole proprietors will likely still face a complex tax form, although even their reporting will be simplified. Double reporting of the Child and Dependent credits and other credits paid to the employee make this part of the system transparent. While the amount of tax owed due to the employees’ labor is no longer transparent to the employee, this need not be a concern since they are no longer directly liable for these taxes. Much of the call for this type of transparency betrays a bias toward less government. In a time when so many items are under-funded, for example housing assistance and the War in Iraq, such a bias is parsimonious at best and treasonous at worst. These proposals are stable to the extent that the Business Income Tax is designed to fully cover domestic and CONUS military spending. Historically, such spending only changes incrementally, as will the tax expenditures included in the business income tax.
Failure to collect personal income surtaxes shifts the burden for collection of those monies taxed at a higher rate to lower-wage workers indirectly taxed by the business income tax. Such a shift will decrease aggregate demand, leading to recession or worse. There are two options for continuing to collect higher tax payments from wealthier individuals without slowing the economy: a surtax on the employer’s Business Income Tax for payments to higher income employers and shareholders or retention of the Personal Income Tax for these individuals.
Overall, economic growth and competitiveness will increase as lower income individuals receive a higher wage. The training provisions and the transfer of family support from the entitlement system to the tax system will decrease crime as it decreases poverty. The cycle of fatherlessness and crime in poor communities will be broken, yielding more productive workers and less drug dealers. Incentiving childbirth with this tax credit will make the U.S. more competitive by increasing the number of potential workers, lowering per capita retirement costs.
Retention of an income tax and progressivity have their own economic benefits. Economic data from the last 40 years shows that when Democrats cut the budget the economy grows, while Republicans only get growth by running a deficit. Statistical analysis shows that when the budget is reduced to its impact on the financial markets (deficit + net interest) and this figure is expressed as a percentage of economic growth, Democrats get more growth from cutting the deficit while Republicans get growth by increasing it. Only one factor, which is consistently different between Democratic and Republican regimes, explains this: tax policy. Democrats usually build a more progressive tax structure while Republicans lower taxes on the wealthy, making taxes more proportional. Economically, when you make taxes more progressive taxpayers who are more likely to consume have more money while taxpayers who are more likely to save have less. This spurs economic growth measures because economic growth measures are more closely tied to consumer spending than to saving.
If supply side economists wish to justify a stronger savings sector they need measures of economic health that have nothing to do with spending. However, their policies still fail due to the nature of most business investment. Most business investment models are based on marketing, meaning that demand for a new or existing product causes firms to put resources into plant and equipment to produce that product. If there is no demand for the product no investment is made (investment managers who recommends replacing equipment without demand solely because the cost of capital is low do not stay employed for long). Additionally, if there is higher aggregate demand, also known as economic growth, then it is more likely that an individual product catches on, leading to high return on investment in plant and equipment.
Compliance and administration costs will decrease as the number of direct taxpayers decrease. These costs will only increase marginally for employers, since they already must keep detailed employment and tax records on their employees. Small additional costs will be incurred in tracking the child and dependent tax credit, although these should not be dissimilar to the costs associated with reporting wages currently.
III. Transition, Tradeoffs and Special Issues.
As previously stated, the consolidation of a more robust child tax credit will serve as a disincentive to abortion and will be helpful in increasing the number of births, thus counteracting the aging of society. As such it will attract support from both the pro-life and living wage movements. The home building, mortgage and health care industries and state and local governments maintain their current advantages in these proposals. Failure to let them do so is like picking a fight with the school bully for no good reason. Unlike the consumption tax, the food, retail and restaurant sectors will not be overly burdened by these proposals, where a consumption tax will negatively impact these industries and invite retaliation. Other industries seeking special tax breaks that are not as well distributed to the entire population will not maintain these advantages under these proposals.
Transition concerns are less than with the inauguration of a consumption tax. The overwhelming majority of employers already collect payroll and income taxes from their employees’ paychecks. These proposals simply make the employer directly liable for these taxes rather than leaving ultimate responsibility with the employee. Employers will need to inaugurate systems to track and claim a few new deductions and credits. The vast majority of the transition costs will be with the IRS, who must rewrite instructions, pamphlets and software. However, in this day and age the entire process might become mostly paperless with tax filing becoming a part of the firm’s accounting system.
We have assumed that the Business Income Tax will be revenue neutral as a substitute for non-retirement payroll taxes, current business income taxes and for personal income taxes, credits and deductions at the 25% rate and below (including the first 25% of the 28%, 33% and 35% rates). We encourage adoption of a final rate which fully funds domestic non-retirement and CONUS military operations. In order to maintain revenue neutrality while the current tax rate cuts are in effect the surtax rates would be adjusted so that only the difference between current revenues and proceeds from the business income tax above. We assume that after 2010 the tax cuts on higher income workers will be allowed to sunset, which we believe is necessary for the health of the economy. Finally, we recommend sunsetting the personal income surtax upon the retirement of the entire public debt. This gives higher income taxpayers an incentive to support higher rates in order to see the surtax disappear.
Update: For interesting ideas along the same lines, see Dr. Carl Milsted's Holistic Politics for How to Tax Corporations and how to get people above the poverty line with a fuzzy cutoff.
posted by Michael Bindner at 3:48 PM
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