The need for tax reform is unquestioned. It could be argued that our current tax code presents twin threats—clear and present—to the future of our country. No one—left, right, or center, pollster, pundit or politician, comedian, clergy or clown, soldier, sailor or shopkeeper—no one has suggested our current tax code makes any sense. Even the IRS official charged with the responsibility to evaluate the equity and efficiency of our tax code has reported to Congress that the ambiguity and inequity caused by the complexity of our tax code beg for meaningful tax reform.

The problem, however, is not that we lack for meaningful reform proposals, at least not in this current presidential election cycle. Whether those proposals make any sense is another question entirely. What we do lack is the political leadership willing to move such proposals forward. We need someone who will bring a proposal to Congress and drive enactment of meaningful reform.

Senator Paul, one of many Republican presidential candidates (actually, a Libertarian seeking the Republican nomination) has proposed his Flat and Fair Tax Plan. With respect to developing a "flat" tax plan that is fair, he believes the adage "never the twain shall meet" to be untrue. Like all the others, his proposal merits close scrutiny and a detailed examination.

In my previous post, I was critical of the whole notion of a “flat” tax. I even asserted that no such thing really exists. Although I believe that holds true with Sen. Paul’s proposal, he gets close.

One problem with most flat tax proposals is that they fail to address payroll taxes. A second major drawback is that most proposals generally treat different income differently, either excluding certain types of income or taxing disparate types of income at a different rate. Taken together, these two characteristics tend to make a tax plan described as “flat”, well, let’s just say more like a Belgian waffle than a pancake.

Rand’s proposal eliminates payroll taxes, among others. His proposal also treats all income the same, whether from working or investing. Maybe the Senator has proposed a tax reform plan that will truly give us a pair of Siamese twins. A plan that approximates a flat result and enhances the equity of our tax system.

As an aside, the Senator has drawn some criticism for his antics on destroying the existing tax code. But why, exactly? He did not call for the elimination of the Internal Revenue Code in a vacuum. So why is all this criticism directed at someone who advocates blowing it up? Or taking a chain saw to it? Or burning it in a wheelbarrow? Apparently, he is willing to look foolish to make a point. He just may possess the leadership to get something done.

Whether you agree or disagree with his proposal, he has suggested an alternative which, like the Fair Tax proposal, offers meaningful reform. Let’s take a look at the specifics.

First, let’s examine yet again the whole idea of flat. The senator proposes “a low, broad-based tax of 14.5% on individuals and businesses.” The plan also eliminates the payroll tax on workers. What is the practical impact of those two measures? Take a look at the following chart, which considers a family of four not claiming any deductions that are allowable under Senator Paul's plan. For the current tax burden, the standard deduction is used.

I’m not sure about you, but that line doesn’t look particularly flat to me. Close but no cigar! It looks reasonable, just not flat.

As I have stated, unless every dollar—the first and the last—regardless of the type of dollar—whether from working or investing—is taxed at the same rate, it is impossible to end up with a “flat” result. In my book, The F-Word, I describe the difference between marginal rates and effective rates. That difference is what creates the slope in the above graph. Despite the application of one rate, taxpayers end up with widely varying effective rates.

That’s not necessarily a bad thing. I just wish politicians would heed the comment Rhett made to Scarlett in Gone with the Wind. He told her that that they could, “Look things in their eyes and call them by their right names.” Why can’t Congress do the same? What I suggest is that those who favor a “one rate” plan use that name: ONE RATE.

Under this proposal, some taxpayers are eligible for a refundable credit (for low-income working families, the plan would retain the earned-income tax credit), and all taxpayers are allowed to deduct the first $50,000 earned. Because of those two factors, the Senator’s plan creates effective rates that range from a minus 20% (taxpayers actually receive a payment from the government) up to a maximum of 14.5% (although no taxpayer ever truly reaches that percentage.)

Pragmatically, this plan approximates one in which everyone pays tax “…in proportion to the revenue which they respectively enjoy under the protection of the state…” just as Adam Smith suggested.

Conservatives may disapprove of this plan because it taxes investment income. Liberals may criticize the fact this this plan caps the tax rate at 14.5% even on the wealthiest. The chart demonstrates that this plan is provides tax relief, particularly on middle-income taxpayers, compared to the current plan. On average, those families earning between $50,000 and $250,000 realize tax savings equal to 10% of their income.

Lower-income families also benefit from this proposal as it eliminates duties and tariffs, which are indirect, hidden taxes. Ultimately these are paid by the end user—consumers—and their elimination makes federal taxes more progressive.

It must be stated that those earning much more receive a much larger tax savings. For the wealthiest Americans, this plan would bring average tax rates down well below current levels. This fact is somewhat offset, at least for those earning less than $400,000, by the fact that all investment income would now be subject to tax.

It is fair to say that flat beer is nearly unpalatable. As I say good-bye, I embark in fair weather to enjoy a full-headed adult beverage. You don’t have to go home but you can’t stay here.

 

Posted
AuthorDoug Spiker