March 11, 2009

The alternatives to our tax system - take some NO-Doze

Now to address the alternative tax ideas out there.

Fair Tax
Proposes changes to the federal tax laws of the United States that would replace all federal income taxes with a single national retail sales tax. The plan has been introduced into the United States Congress as the Fair Tax Act (H.R. 25/S. 296). The tax would be levied once at the point of purchase on all new goods and services for personal consumption. The proposal also calls for a monthly payment to all family households of lawful U.S. residents as an advance rebate, or 'prebate', of tax on purchases up to the poverty level. The sales tax rate, as defined in the legislation, is 23 percent of the total payment including the tax ($23 of every $100 spent in total—calculated similar to income taxes). This would be equivalent to a 30 percent traditional U.S. sales tax ($23 on top of every $77 spent before taxes).

With the rebate taken into consideration, the FairTax would be progressive on consumption. but would also be regressive on income at higher income levels (as consumption falls as a percentage of income. Opponents argue this would accordingly decrease the tax burden on high income earners and increase it on the middle class. Supporters contend that the plan would decrease tax burdens by broadening the tax base, effectively taxing wealth, and increasing purchasing power. The plan's supporters also argue that a consumption tax would have a positive effect on savings and investment, that it would ease tax compliance, and that the tax would result in increased economic growth, incentives for international business to locate in the U.S., and increased U.S. competitiveness in international trade. Opponents contend that a consumption tax of this size would be extremely difficult to collect, and would lead to pervasive tax evasion. They also argue that the proposed sales tax rate would raise less revenue than the current tax system, leading to an increased budget deficit.

There are some good things and bad things about this. 1) I believe it is constitutional where our current income taxes really are not. 2.) It does not tax you on wages, only on what you buy. So you are not penalized for investing or saving money. On the negative side: 1) raising taxes on the middle class hits close to home for most of us. That would not be popular. 2) It is still progressive, which is somewhat against our founders’ intentions.

The Flat Tax
The Flat tax basically says everyone pays the same % of income. Say 17%.

Proponents of the flat tax claim it is fairer than the current tax system, since everybody pays the same proportion. Opponents point out first that it might not make sense for everyone to pay the same proportion when some get advantages of prosperity. Also, they note that for the state to raise the same amount of money under a flat rate tax requires that the rich pay less and the poor pay more than they would under a more progressive tax system. Proponents respond to this argument by saying that a flat tax would remove economic disincentives and encourage economic growth, thus leading to higher incomes and more tax revenues. So taxpayers across income ranges could be paying at the same or lower rate than their old system.
Proponents claim that since everybody pays the same rate, it treats everyone equally and thus is fair to everyone.
Opponents of the flat tax, on the other hand, claim that since the last $100 of income of a family living near poverty is considerably more valuable to them than the last $100 of income of a millionaire, taxing that last 100 of income the same amount despite vast differences in the need of the money is unfair. Many flat-tax proponents agree since and Flat Tax proposals are not truly totally flat but have a threshold below which income is not taxed at all. Therefore, with the exception of flat-tax proponents who argue for no deductions and taxation of all income at one flat rate, both proponents and opponents agree in principle if not in degree with the basic premise of the concept of a progressive tax system.

However, the sizable exemptions provided under most flat tax proposals go far in restoring effective progressivity (progressivity means like it is now, heavily weighted toward the rich paying a disproportionate share)
The issue of removing deductions, exemptions and special treatments is also relevant to the tax burden, if those special treatments currently benefit the wealthier of society.
As an example, the tax debate in the UK has recently (2007) focused on the fact that hedge fund managers, some with multi-million pound (dollar) incomes, "pay less tax than a cleaning lady” (as a %), because the hedge fund manager's "income" qualifies as capital gains, taxable at 10%, rather than the cleaner's employment income taxable at 33% (22% income tax plus 11% social security charge). A flat tax that taxed both at the same rate is argued to be fairer than the current, supposedly progressive, system.

We must also consider fairness in relation to the broader concept of justice. Proponents argue that a flat tax would:

ü by its greater simplicity, reduce taxes for each person, rich and poor; and
ü by stimulating economic growth, produce more government revenue, which could be directed towards programs that benefit the poor.
ü Thus, even if a flat-rate taxation is less fair than graduated taxation as a concept, it could produce more social justice.

Administration and enforcement
A flat tax taxes all income once at its source. Hall and Rabushka (1995) includes a proposed amendment to the US Revenue Code implementing the variant of the flat tax they advocate. This amendment, only a few pages long, would replace hundreds of pages of statutory language (although it is important to note that much statutory language in taxation statutes is not directed at specifying graduated tax rates). As it now stands, the USA Revenue Code is over 9000 pages long and contains many loopholes, deductions, and exemptions which, advocates of flat taxes claim, render the collection of taxes and the enforcement of tax law complicated and inefficient. It is further argued that current tax law retards economic growth by distorting economic incentives, and by allowing, even encouraging, tax avoidance. With a flat tax, there are fewer incentives to create tax shelters and to engage in other forms of tax avoidance.

Under a pure flat tax without deductions, companies could simply, every period, make a single payment to the government covering the flat tax liabilities of their employees and the taxes owed on their business income. For example, suppose that in a given year, ACME earns a profit of 3 million, pays 2 million in salaries, and spends an added 1 million on other expenses the IRS deems to be taxable income, such as stock options, bonuses, and certain executive privileges. Given a flat rate of 15%, ACME would then owe the IRS (3M + 2M + 1M) x0.15 = 900,000. This payment would, in one fell swoop, settle the tax liabilities of ACME's employees as well as taxes it owed by being a firm. Most employees throughout the economy would never need to interact with the IRS, as all tax owed on wages, interest, dividends, royalties, etc. would be withheld at the source. The main exceptions would be employees with incomes from personal ventures. The Economist claims that such a system would reduce the number of entities required to file returns from about 130 million individuals, households, and businesses, as at present, to a mere 8 million businesses and self-employed.

Under a flat tax, the government's cost of processing tax returns would become much smaller, and the relevant tax bodies could be abolished or massively downsized. The people freed from working in administering taxes will then be employed in jobs that are more productive. If combined with a provision to allow for negative taxation, the flat tax itself can be implemented in an even simpler way. In addition, such a tax reduces the cost of welfare administration significantly.

Some claim the flat tax will increase tax revenues, by simplifying the tax code and removing the many loopholes corporations and the rich currently exploit to pay less tax. The Russian Federation is a claimed case in point; the real revenues from its Personal Income Tax rose by 25.2% in the first year after the Federation introduced a flat tax, followed by a 24.6% increase in the second year, and a 15.2% increase in the third year.[9] The Laffer curve predicts such an outcome, but attributes the primary reason for the greater revenue to higher levels of economic growth. The Russian example is often used as proof of this, although an IMF study in 2006 found that there was no sign "of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reforms" in Russia or in other countries.

Overall structure
Some taxes other than the income tax (for example, taxes on sales and payrolls) tend to be regressive. Hence, making the income tax flat could result in a regressive overall tax structure. Under such a structure, those with lower incomes tend to pay a higher proportion of their income in total taxes than the affluent do. The fraction of household income that is a return to capital (dividends, interest, royalties, profits of unincorporated businesses) is positively correlated with total household income. Hence a flat tax limited to wages would seem to leave the wealthy better off. Modifying the tax base can change the effects. A flat tax could be targeted at income (rather than wages), which could place the tax burden equally on all earners, including those who earn income primarily from returns on investment. Tax systems could utilize a flat sales tax to target all consumption, which can be modified with rebates or exemptions to remove regressive effects (such as the proposed FairTax in the U.S.)

Border adjustable
A flat tax system and income taxes overall are not inherently border-adjustable; meaning the tax component embedded into products via taxes imposed on companies (including corporate taxes and payroll taxes) are not removed when exported to a foreign country (see Effect of taxes and subsidies on price). Taxation systems such as a sales tax or value added tax can remove the tax component when goods are exported and apply the tax component on imports. Under a flat tax, domestic products are at a disadvantage to foreign products (at home and abroad). Such a system greatly impacts the global competitiveness of a country. Though, it's possible that a flat tax system could be combined with tariffs and credits to act as border adjustments (the proposed Border Tax Equity Act in the U.S. attempts this). Implementing a income tax with a border adjustment tax credit is a violation of the World Trade Organization agreement.

Race to the bottom

An argument raised by opponents of the flat tax is that corporations or wealthy persons might move to countries with lower taxes, especially in a single country context. The argument states that this would lead to a race to the bottom in which countries compete to offer ever-lower taxes for the rich, so that the rich become even richer, while the poor and middle classes, unable to financially handle relocation to another country, are left to shoulder the entire cost of all government services. A consequence would be an ever-worsening under-funding and neglect of the public sector.

OK so now if any of you are still awake… I see problems with both. But I see bigger problems with what we are doing now. I think we need a Flat Tax that is slightly Progressive. I think taxes should be based on consumption, and not wages. I want my cake and eat it too.

But if we are going to keep the progressive tax and really put it to the rich why stop at just taxing them more for what they make. Let’s be really socialistic… Lets make electricity rates contingent on how big your house is….let’s make what you pay at the doctor contingent on how nice you dress…let’s make what the price the restaurant charges higher based on what car you drove there… how about charging more for the car you buy based on your job? That sounds silly doesn’t it? Well then why is taxing a person more on what they make so much more fair and reasonable?
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