March 3, 2011

There's Gotta Be a Better Way

Hatched by Dafydd

...But if there is, I'll bet we never implement it.

I just finished our taxes (federal and California). Here are the numbers...

No, not our gross, adjusted gross, or taxable incomes, our tax liabilities, or our refunds, you stretch-eared peddlers in gossip! Who would be reckless enough to post something like that on the World Wide Wikileak? No -- I mean these numbers, the really important ones:

  • Federal tax return: 11 forms, schedules, and whatnot totaling 16 pages.
  • California tax return: 20 forms, schedules, and suchlike totaling 26 pages. (Larger because the state return requires most of the federal return as an appendage.)

...And we are thoroughly middle-income, with a job, a mortgage, a small business, and with some charitable donations. As Jerry Pournelle is wont to say on the spur of a hat, ye flipping gods!

Note that neither total includes all the various worksheets required to calculate the amounts that must go on each form. Those are extra: You have to fill them out, but you don't necessarily send them in (though some you must).

All I can say is... thank goodness for Turbo Tax. I'm sure other tax-preparation does just as well; but why in the world should ordinary people with ordinary tax returns be de facto required either to purchase and learn how to use such software or else hire a professional tax preparer to run the program for you? It's unconscionable.

Apart from the money -- we pay far too much in taxes in the United States of Appropriation -- the sheer complexity of our income-tax system swiftly approaches actual tyranny: When ordinary, reasonably well educated adults cannot fill out a required (on pain of incarceration!) form without microprocessor hand-holding or a paid guy with a green eyeshade; when the forms are so voluminous and confusing that costly mistakes are almost guaranteed; when there are so many rules and regulations that ordinary blokes live in dread of the Infernal Revenue Service "reinterpreting" them our of their refunds (and conceivably into la calabooza), then the tree of liberty has rotted away, and the world has gone utterly mad.

Remember that the Boston Tea Party was not over the size of the tea tax but the process that enacted it; there is nothing absurd about a people revolting over the process of paying it, as well. For many of us, the angst of calculating Uncle Sugar's extortion payment is as bad as the actual amount of squeeze we must cough up.

For the sake of our nation's sanity, we must find some way to simplify the taxing system. There are of course several ways to do so; the European taxing model generally comprises only two simple steps:

  1. Tell us how much you earned last year.
  2. Send it in.

That's simple enough, but I'd tolerate a little more complexity than that just to avoid having to learn how to speak with a comical accent.

Many countries' system is even simpler, comprising but a single step:

  1. Here is allowance we have allotted you, Comrade. You have problem with that?

But surely there must be a happy medium somewhere between one line and 42 pages of detailed accounting gibberish.

Some advocate a national sales tax to take the place of the income tax, but I'll tell you what would actually happen if we tried it: For the first eight or nine iterations of the bill, it would replace the income tax; but then some Democrat would propose an amendment, swiftly adopted by all the power-mad statists in Congress... and the final bill as enacted and signed would give us -- a national sales tax in addition to the bloody income tax! The putative "Fair Tax" is right out, in most people's opinion (including mine).

So let's consider the "flat" tax instead, so-called because everybody would pay the same flat percentage of his income: How much did you make? Pay us X% of that amount, whether you're Rupert Murdoch or Schneider the building super. In the pure form of the flat tax, there are no exemptions or exceptions; in a modified version, which is what flat-taxers mostly push, the first X dollars are exempted from the tax, in order not to tax paupers.

As our first rough, back-of-the-thumbnail calculation, note that the Gross Domestic Product of the United States is around $14.7 trillion, while the total tax revenues for the country is about $2.2 trillion. Last year, 42% of taxes collected came from personal income taxes, while 9% came from corporate taxes, for a total of 51% or $1.1 trillion; call this the Earnings Tax, or ET. (The rest was Social Security-like taxes, 40%, and excise, estate, and gift taxes, 9%.)

The GDP represents what we collectively "earn," while the ET is what would be replaced by a flat tax. Simple division indicates that, in order to make the pure flat tax revenue-neutral (collect about the same as the present system), the percentage would have to be about 7.5% taxed on all income, no matter how it was earned (wages, business income, dividends, investments sold for profit, rents and royalties, everything.)

But suppose we have a modified system instead, one that exempts the first, let's say $15,000 of every person's income; so a family with two earners would get a $30,000 exemption, and so forth. We would clearly need a higher percentage tax on the rest of income.

How much total would be exempt from the flat tax? Again, the roughest of calculations suggests it would be the first $3.4 trillion of GDP (I multiplied $15,000 by the number of adults in the U.S., about 228.2 million). Thus the rate of the modified flat tax on the taxed portion of GDP ($11.3 trillion) would be about 9.7%. Even that rate doesn't seem that bad.

Three major caveats, however:

  • We arbitrarily picked a floor exemption of $15,000 per person; if instead we picked $18,000, that would change the tax rate for a modified flat tax to roughly 10.4%... so the floor exemption dramatically affects the tax rate.
  • These numbers are static; they don't take into account how changing the tax system from massively complex to fairly simple might energize the economy. This would increase the tax base, thus allowing us to decrease the rate, assuming Congress doesn't mind letting people keep more of their own money. (And while we're on the subject of Utopia, maybe they'll all simultaneously stop selling their souls for campaign funds and demagoguing issues for political gain, as well.)
  • We assumed the flat tax would be revenue neutral, but there is no reason to "lock in" the high taxes we have today. We could also take the opportunity to reduce taxes. (And maybe we'll invent Star Trek replicators next Thursday after lunch, and we can all have a free lunch.)

But those changes probably wouldn't budge the meter that much. If every money-earning entity was taxed at the same rate, it should be do-able at about 10%. But remember, that's 10% of the total income (line 22 of your Form 1040) minus the exempted amount (the $15,000 per person) -- not 10% of the "taxable income," as currently defined, or even the "adusted gross income," both of which are artificially reduced by a lengthy series of dubious and increasingly improbable deductions, exemptions, credits, shelters, alternative accounting practices, loitering, malingering, disturbing the war, and mopery with intent to gawk.

Even with all caveats and roughness accounted for, it still seems plausible; and it would certainly make life simpler for most taxpayers, though it might lead to serious unemployment among accountants and tax preparers. Looking at my own return, under the system above, I would pay about 20% less; richer people and businesses would pay somewhat more; but they would save on the cost of preparing their taxes, complying with the tax laws, and no longer having their own economic activity distorted by the tax code (that is, the government would no longer be able to control people's behavior by monkeying with the tax code). I call that a win-win.

But this is sheer folly; we're never going to change, for the simple reason that every jot and tittle of the tax code, no matter how goofy, was put there due to intense lobbying and campaign-cash pressure by some powerful special interest; and that interest will fight hammer and tooth to keep it, no matter the cost. Having such strong financial interests in every syllable and punctuation mark of the tax code, the lobbyists will always have far more incentive to fight to keep it than the general public has to fight to eliminate it; thus each deduction will abide: They are the eternal earmarks of the tax-evading nomenklatura.

So in the end, I'm left where I began: Thank goodness for Turbo Tax!

Hatched by Dafydd on this day, March 3, 2011, at the time of 2:32 PM

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Comments

The following hissed in response by: snochasr

I think you dismiss the FAIR tax too quickly. Built into the legislation is repeal of the 16th amendment, with effectivity tied to ratification of that repeal. And while a flat tax would be far simpler than what we currently have, we still would have to declare our income (what is income?) The FAIR tax would be far simpler, with absolutely no forms to fill out at all, and no chance for you to make an error. The $300 Billion we currently spend just to comply with the IRS code could be spent on something useful.

The other problem with the Flat tax is that it isn't fair. Even if you exempt the first poverty level of income (roughly $38,000 for a family of four), most people at that income level pay far more in Social Security and sales tax than in income tax. The FAIR tax replaces ALL federal taxes and includes a full exclusion up to poverty level, just like the flat tax does, so it is perfectly progressive above that point. But since it is a sales tax, there is no tax on savings or investment like there would be with most flat tax proposals, and THAT is what will stimulate the economy. Add to that a 20% reduction in the cost of our exports and a 20% increase on the cost of imports, and we've solved yet another problem. And Social Security reform is "free."

I still might agree that there are huge "special interests" aligned against the proposal, including the unwillingness of Congress to give up micromanagement of the economy through the tax code for fun and profit, but if we're going to have the fight, let's fight for the best result.

The above hissed in response by: snochasr [TypeKey Profile Page] at March 3, 2011 5:14 PM

The following hissed in response by: Dafydd ab Hugh

Snochasr:

[I]f we're going to have the fight, let's fight for the best result.

I strongly disagree that a national sales tax (NST) -- let's call it what it is, rather than the tendentious "FAIR Tax" -- is "the best result." First of all, it's a dreadful idea for citizens to be taxed without knowing how much they're paying every year. Such a blind arrangement makes it disturbingly easy for government to raise taxes; the average person wouldn't even realize he's paying more at the register.

Plus, when folks don't feel the pain, as they do here every year on April 15th (or earlier), there's less demand to lower taxes or restrain spending.

This is just what happens with the value-added taxes (VATs) and NSTs throughout Europe and Asia: Whenever the government "needs" more money (that is, whenever it has overspent what it actually took in), it quietly and without fanfare jacks up the VAT to cover the difference. And I have never heard of people complaining about an NST or VAT; they don't even know where inflation ends and tax hikes begin.

Second, you contend that "Built into the legislation is repeal of the 16th amendment, with effectivity tied to ratification of that repeal;" but that's not quite right, is it? It's more accurate to say such a repeal is built into the proposed legislation.

But by the time it would eventually pass, some representative or senator will have offered an amendment to strip out that requirement and implement an NST immediately... as an adjunct to the income tax, not a replacement for it.

Oh, they'll keep it really low at first: "Just let us have a modest 5% on all sales; then when we get our house in order, and the system is proven, we'll raise the NST somewhat and completely eliminate the income tax... we promise!"

And they'll fulfill that promise -- halfway; the NST will surely rise. But can you picture the InTrade over-under on whether the income tax ever goes away, once both systems are operating side by side?

Finally, I agree with you that people pay far too much for Social Security and Medicare, especially given its abysmal ROI. But the solution is not to replace it with a pig in a black box. The solution is twofold:

  • Privatize SS 100% (with a required insurance policy to cover those whose investments go sour, even following the rules);
  • Replace the defined benefits of Medicare with a defined contribution to a private health-insurance policy.

Of course there are improvements in healthcare we must make anyway, such as tort reform, allowing cross-state insuring, making it easier for companies to offer different kinds of group policies, and pushing the low-cost combination of a medical savings account and a catastrophic-care policy, especially to young people.

But you would still need to make those reforms whether you enacted a flat tax, an NST, full socialized government medicine, or stuck with the current system.

Dafydd

The above hissed in response by: Dafydd ab Hugh [TypeKey Profile Page] at March 3, 2011 6:22 PM

The following hissed in response by: Dick E

Dafydd-

…though it might lead to serious unemployment among accountants and tax preparers.

You say that like it’s a good thing. As a CPA, I resemble that remark!

Seriously, I agree with your entire argument, starting with the insanity of every burger flipper at Mickey D’s needing (or fearing he needs) professional tax help. I have argued this for years.

Unfortunately, you are also correct about the politics.

Flat tax, FAIR tax, VAT, whatever. None of these will ever, in our lifetimes, replace the income tax. A big reason is that none of them look progressive enough to satisfy liberals. They will never settle for a tax system that doesn’t subject “the rich” to a much higher tax rate than ordinary Joes. (Although they don’t seem to mind that the effective tax rate, after deductions, credits, etc., may not be anywhere near as high as the statutory rate.)

The above hissed in response by: Dick E [TypeKey Profile Page] at March 3, 2011 7:52 PM

The following hissed in response by: snochasr

You are correct, perhaps, to criticize the FAIR tax as a "proposal" rather than something actually passed through the sausage grinder of Congress, but at least there legislation written to take before Congress, and with significant number of co-sponsors. Your proposal hasn't gone anywhere near that far; what makes you think Congress couldn't and wouldn't mangle that to the point of being unrecognizable, even before it was down on paper? For example, what prevents them from defining your employee benefits as income? Or adding back one "essential" exemption after another, like "income" from a protective tariff?

The above hissed in response by: snochasr [TypeKey Profile Page] at March 4, 2011 2:51 PM

The following hissed in response by: snochasr

The FAIR tax would be the ultimate in visibility. Every time you purchased something there it would be. Even with a flat tax, everything you purchase will still have all sorts of embedded taxes in it, just like a VAT tax, which should never be confused with the FAIR tax. The FAIR tax is set to replace all federal taxes, at 23%, and with all that visibility, it would take an act of Congress to raise it. Right now Congress raises taxes every year in a thousand ways and nobody ever sees it, buried in thousands of pages of IRS regs. (By the way, try calling 3 or 4 different IRS offices for advice on some esoteric point sometime. You'll get at least 4 different answers.)

As for Medicare and Medicaid reform, yes, all we need to do is "voucherize" it, and costs will drop like a stone. Problem more or less solved. Social Security is more difficult, and I have proposed phasing it out over 40 years, replacing it with private accounts. If it were economically viable I would go cold turkey on it like Chile did but it would have to be done while the Trust Fund was still large, like last year. The beauty of the FAIR tax is that it reforms Social Security without ever "touching" it. Those already receiving benefits continue to receive them, but all Social Security taxes paid by employees stop immediately, therefore earned benefits cease to accumulate. Those close to retirement continue to get most of what they would have earned anyway, while those just entering the workforce, 40 years from retirement, won't "contribute" anything and will receive no benefit, according to current SS rules. In the meantime, thanks to the FAIR tax, everybody's paycheck just increased by 23%, and EVERY savings account or investment is tax free, like an IRA. That kind of SS reform is the kind that will rapidly grow the economy, and those investments will grow right along with it.

The above hissed in response by: snochasr [TypeKey Profile Page] at March 5, 2011 7:34 AM

The following hissed in response by: Dafydd ab Hugh

Snochasr:

This is the same sort of approach that Obama and his progressive cohort take, albeit in a different direction: a massive, complete transformation of our entire economy, changing everything all at once, with unpredictable but irreversible consequences whose complexity is overwhelming. Once we undertake such a transformation, there's no turning back -- even if we realize it was a dreadful mistake.

It's a perfect example of the Grand Unified Theory of Everything: Why, if only we made this one revolutionary transformation of everything, we'd be living in Solla Sollew, where they haven't a trouble (or at least very few). Other examples include:

  • Let's get rid of the electoral college -- that will solve all of our problems with elections, campaigning, corruption, and absurdities like the 2000 election!
  • Let's return to the gold standard -- that will completely eliminate all recessions, depressions, banking scandals, housing-market collapses, and inflation forevermore!
  • Let's give the president a line-item veto -- that will break the logjam on vital legislation, end all earmarks, stop all congressional corruption, and reconcile all that partisan bickering!
  • Let's implement fully socialized government medicine -- a panacea that will cure all the ills of commercial medicine, including the uninsured, poor access to medicine, the doctor drain, overmedicating, undermedicating, medical bankruptcy, malpractice suits, and even produce staggering new treatments for all the diseases that plague Mankind!

It would be nice if such "let's change everything!" theories really worked; sad to say, they don't. The world is what it is.

You can always get many people to sign onto something like the National Sales Tax; it's "cheap grace" -- the cosponsors get brownie points for being cool and edgy, but they know it will never, ever, ever be enacted. The vast majority of those climbing aboard would softly and suddenly vanish away if they thought it actually had a prayer of passing; they're utterly insincere in their support. The few flat-Earth fanatics who truly believe in it are isolated and powerless.

A flat tax is something that could actually be enacted, because it's not a radical transformation. Reagan crunched it down to three tax brackets and cut out many bizarre deductions; the mistake was allowing more than one bracket -- because if there are three, then why not four? And if some deductions are allowed -- why not this one and that one?

The flat tax is just a more robust version of what we already know worked well for quite a while and is still working better than was the multi-bracket, massively overtaxing system we had pre-Reagan. Instead of three, we have one; instead of some, we have none. It has a significant chance of passage... which is why everyone treads much more softly around it: They're actually taking it seriously.

In the end, I believe Congress will sink it; congressmen of both parties have too much invested in the current system, since they use tax breaks to control everyone's economic behavior (and sometimes their personal behavior). But in a real vote, it would definitely come closer to passing than would any version of an NST.

Dafydd

The above hissed in response by: Dafydd ab Hugh [TypeKey Profile Page] at March 5, 2011 12:56 PM

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