Taxes are one of those things that America’s love to hate and it’s something that touches every working person in our country. It’s interesting to note that at the Founding of our country, the “single” source of income for the government was tariffs. It wasn’t until 1909 that the income tax was proposed and then ratified by the states and added to the Constitution as the Sixteenth Amendment in 1913 (Ginsberg, Lowi, Weir, p 650). In 1934, individual income tax accounted for 14 percent of federal revenue, by 2004 that figure had risen to 43 percent (Ginsberg, Lowi, Weir, p 640).
The tax system in the United States is a progressive system, meaning that as the amount of income increases, so does the percentage of tax to be paid. Federal gift and estate taxes as well as most state income taxes are also progressive in nature. Sales taxes are considered a regressive form of taxation as everyone pays the same rate. A regressive tax means that as you earn more the percentage of your income that is applied to sales taxes becomes less, conversely that means that for a lower wage earner a higher percentage of their incomes is used to pay sales tax. Social Security is another example of regressive taxation (Ginsberg, Lowi, Weir, p 640).
The current tax rates in the
Tax reform is something most American’s can agree upon as something that needs to happen within the complex system that has evolved in the Department of the Treasury with tax collection duties assigned to their agent, the Internal Revenue System. The question though is how do we proceed with reform? What is the best approach to simplify the tax system and make it fair to all citizens? President Bush commissioned an advisory panel in 2005 for Federal Tax Reform, and neither of the two proposals submitted by the panel recommended the Flat Tax.
According to Mitchell (2005) the flat tax would simplify the way taxes are prepared in America. Instead of a myriad of forms and procedures, the flat tax would simplify the taxation process for individuals and businesses alike with a single form for each group. This alone will result in savings in preparation costs which is now estimated at over $100 billion annually while also reducing preparation time. Other benefits of the flat tax include:
- A single flat rate would be levied on each individual or business.
- Eliminate deductions, credits, and exemptions. This would simply the tax filing process.
- Elimination of double taxation on savings and investments. This would mean “no death tax, no capital gains tax, no double taxation of saving, and no double taxation on dividends.” (Mitchell, 2005).
- Would encourage economic growth by not taxing overseas assets of
- Elimination of undo political influence by companies seeking tax advantages from members of Congress, having a positive effect on the legislative process too.
- In the Czech Republic they have a 15% rate on individual income. According to Cardais (2007) though, because people are taxed on their “super-gross income,” the real tax rate is closer to 23 percent. Super-gross income includes health benefits and social insurance.
Something that is interesting though is for many of the countries that are using a flat tax system they are still coupling deductions, exemptions, and other exceptions to their code, thus making many of these countries complicated flat tax zones, something that runs counter to the whole idea of flat tax. Another side effect to the states reduction of income by a reduced tax rate is the possibility of reductions in welfare programs that benefit the lower class citizens.
“To promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service and enacting a national sales tax to be administered primarily by the States” (Thomas, 2007). This is the beginning of H.R. 25 and S. 1025, better known as the “Fair Tax Act of 2007”. Tax reform is a hot topic these days as everyone sees the taxes they pay to the government and invariably everyone believes they are paying too much in taxes. This has led to twelve legislative proposals that are working their way through the 110th Congress for consideration and possible action.
Of the twelve tax reform proposals, seven are flat tax oriented with a basis on consumption as opposed to our current progressive tax system. Three plans simply outline for tax reform and the last two deal with the elimination of the Alternative Minimum Tax (AMT) while even the flat tax plans call to eliminate the AMT. Let’s look at the highlights of the flat tax plans according to James Bickley (2008) with the Congressional Research Service:
- H.R. 25 and S. 1025 are related bills that would impose a 23% sale tax beginning in 2009 to be adjusted as needed. Since 45 out of 50 states are versed in state sales tax collection, tax collection would be moved to the states instead of the federal government. This would qualify as an example of “devolution” by moving the collection of federal taxes from the federal government to the individual states (Ginsberg, Lowi, Weir, p 555). “Every family would receive a rebate of the sales tax on spending up to the federal poverty level (plus an extra amount to prevent any marriage penalty) (Bickley, CSR-6). This 23% rate would not be imposed on exports. “Social Security and Medicare benefits would remain the same with payroll tax revenue replaced by some of the revenue from the retail sales tax” (Bickley, CDR-6). H.R. 25 and S. 1025 would also abolish the Internal Revenue Service after 2011 and “establishes in the Department of the Treasury (1) and Excise Tax Bureau to administer excise taxes not administered by the Bureau of Alcohol, Tobacco, Firearms, and Explosives; and (2) a Sales Tax Bureau to administer the national sales tax (Thomas).
- H.R. 1040, the Freedom Flat Tax Act, would impose a 19% tax rate for the first two years then lowering to 17% thereafter. This plan did provide proposed figures for standard deductions as the current system uses with $25,580 being the married filing jointly deduction. This is meant to ensure lower income families are not paying taxes on this first $25,580 earned. This plan does tax employer compensation provided to the employee without charge. This tax plan would allow an individual or a business to choose to be taxed via the flat tax plan, but once the choice is made it is irrevocable. Taxation on a business would be broken down by gross sales minus the cost of doing business to include business activities, wages, and retirement contributions. H.R. 1040 would also repeal the estate, gift, and generation skipping transfer taxes too (Bickley, CRS-7).
- S. 1040, the Tax Simplification Act of 2007, is very similar to H.R. 1040 and also would begin with a 19% tax rate with a reduction to 17% beginning tax year 2010. One big difference with H.R. 1040 is that this plan is intended for nationwide use for individuals and all businesses. It would require taxing dependent children under the age of 14 on any of their taxable income. Deduction rates are the same as H.R. 1040. S. 1040 imposes the employer provided benefits compensation tax at the same rates of the national tax rate for “government and nonprofit organizations having to add to their wage tax base the imputed value of their fringe benefits” (Bickley CRS-7). Items to be repealed would include “the alternative minimum tax, all income tax credits, estate, gift, and generation skipping transfer taxes, and income tax provision, except certain provisions relating to retirement distributions (Social Security) and tax-exempt organizations.” (Thomas, S 1040). Bickley (CRS-7) also states that this plan is truly a “modified Value Added Tax (VAT).
- “Under the VAT, a business would pay the tax (approximately 17%) on all of the materials and services required to manufacture its product. In effect, the VAT taxes the increment in value as goods move through production and manufacturing stages to the marketplace. Moreover, the VAT paid by the producer will be reflected in the selling price of the goods. Thus the VAT is a tax on consumption.
- The United States is the only country in the Organization for Economic Cooperation and Development that does not have a VAT. Approximately 136 countries around the world use a VAT, ranging from 5% in Japan to 25% in Denmark” (Hoffman & Willis p 1-17/18).
- S. 1081, the Flat Tax Act of 2007, would impose a flat tax of 20% on taxable earned income. This would be earnings over the $25,000 married filing jointly standard deduction and would still provide “additional standard deductions” for the number of dependents of the taxpayer (Bickley CRS-9). This plan still allows for the home mortgage interest deduction. S. 1081 also taxes government and nonprofit employee compensation as S. 1040 would requiring the addition to ones wages the value of fringe benefits received. S. 1081 would also repeal the “estate, gift, and generation-skipping transfer taxes, financing of presidential election campaigns provisions, and coal industry health benefits provisions” (Thomas S. 1081).
- S. 1111, the Fair Flat Tax Act, is a simpler progressive tax with rates of 15, 25, and 35% with the brackets applying at under 30K, between 30K to 120K, then over 120K respectively. A 35% rate would apply to all corporate taxable income. The idea behind a flat rate for corporate income tax is to “eliminate special tax preferences that favor particular types of businesses or activities” (Bickley CRS-9). S. 1111 would repeal capital gains and dividend income taxes and it would keep real and personal property tax deductions while also keeping a health care standard deduction. Would provide the Earned Income Credit (EIC) to taxpayers that did not have children if their income was low enough to qualify for the credit. S. 1111 would also repeal the alternative minimum tax along with other unspecified credits, deductions, and exclusions (Thomas S.1111).
- H.R. 4159, the Simplified USA Tax Act of 2007, is also a simpler progressive tax with rates of 15, 25, and 30% with brackets at under 40K, between 40 K to 80K, and then over 80K respectively. This plan is the most entailed of all submission at 414 pages and has deductions for many items supported by the current system with a noticeable addition of child support as a deduction too. For businesses they would use a cash-flow business tax (a subtraction-method VAT) with a rate of 8% applying up to $150,000 then the rate moves up to 12% after that. All imports would be taxed at the 12% rate. H.R. 4159 would allow the home mortgage deduction and would exempt injury and sickness compensation payments. Rule changes for how Roth IRA’s would be administered would allow tax-free withdrawals from accumulated principal and earnings on principal from the account for any purpose after five years. There is a credit for having paid the Social Security tax and the estate and gift tax would be repealed (Bickley CRS-11).
It is interesting to note that of the seven flat tax proposals, six are submitted by Republican’s with only one by the Democrat’s (S. 1111, which really is a simplification of the current tax system and not a true flat tax). The flat tax appears to be a very partisan issue. When we look at H.R. 25 all 70 Representatives that have signed onto the bill as cosponsors are Republicans with the same holding true for S. 1025, S. 1040, and H.R. 1040.
How fair is the current tax system though? As mentioned before, currently the top income bracket, those earning over $349,700, are paying 35 percent on their income to federal taxes. This is a 4.6 percent reduction from the tax rate that was in effect in 2001, which results in a tax savings of $16,086 for those earning the minimum, while those with earnings in the top one percent of American society are seeing an average savings of over $34,000 a year. During this same tax lowering period, the income for the bottom fifth of society raised a mere 0.3 percent ($18.00). This low figure for the lower wage earner is because most of their income is already not taxable because they’re living below the standard deduction line, meaning they are probably living below the poverty leave and their gains are minimal at best (Ginsberg, Lowi, Weir, p654).
One thing to consider is most people, as much as they dislike paying taxes, when they take their own tax scenarios into consideration tend to approve any reduction to their own tax rate without giving much consideration to the effects of others outside of their own tax bracket. For instance, for a middle class income earner, they received a 2.6 percent decline in their federal tax bill of 2001. Because of this, they were less likely to oppose the 4.6 percent decline in the upper classes tax bill because the current bill still provided them with a favorable outcome. As we’re starting to see, “people are happy to have their own taxes reduced and do not think about how such reductions may be exacerbating inequality by giving even bigger tax breaks to the wealthy” (Ginsberg, Lowi, Weir, p654-5).
Some important questions regarding the flat tax is how will the government compensate for the lost revenue that it currently receives from those in the higher tax brackets? Ginsberg, Lowi, and Weir point out that the government receives approximately 43 percent of its operating funds from the individual taxpayer (p 640-1). If we go to a flat tax, most plans still provided a standard deduction, so lower wage earners still will have a favorable tax situation, but now where will the government recoup the funds the upper level earners put into the “system”?
We have to also consider what our tax money is used for. Consider how are some of our current social policy programs being funded? Funds collected from individuals are providing 37 percent of the funding for welfare programs such as Social Security, Medicare, and Medicaid while we find that corporate taxes have fallen from 17 percent to a current 2005 rate of 13 percent since 1970 (Ginsberg, Lowi, Weir, p 671). These programs are things we must consider and ask what would happen to them if we convert to a flat tax system and how the tax burden of today’s society would actually become a regressive tax system and be nothing more than a BIG tax break for the wealthy in American society.
There are other issues that we should be concerned with in the flat tax system. Will lower income families be able to afford homes when they’ve counted on the interest deduction they would receive under the current system? And what about contributions to charitable organizations, will they decrease also with the loss of deductions? For those working for the government and nonprofit organizations having to include fringe benefits as wages for tax purposes is disheartening and could cause many benefits that people rely on to vanish. For instance, an employer or employee, depending on which tax plan was implemented, would have to pay tax on the value of a company provided employees health care insurance plan, something that is currently exempt from taxation, so if it cost the company five thousand dollars a year for health care benefits for each employee, they’d have to pay tax on that five thousand dollars for each employee.
As we have seen, there are many ideas for tax reform via the flat tax system and they have many similarities too. Most take aim at the estate, gift, and generation-skipping transfer taxes along with the ever despised alternate minimum tax. The term flat tax though appears to have come to symbolize tax reform though more than a true flat tax that is applied to all citizens across the board. Hopefully if a proposal makes its way out of Committee, American’s will take the time to not just to look at how the proposal effects themselves, but to look at the “big picture”. How will these changes affect others above and below me in the tax system and does it seem fair? We must also remember all the services that we as a nation provide and consider how a proposed change is going to affect those programs in the future.
References withheld so anyone doing their own college work will need to go and find them on their own... plus... a little google work plus the use of "turnitin" by a prof... and opps... so please feel free to get some ideas from this... but just be wise in doing so...
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