Overhauling the tax code

I’ve long been a proponent of a overhauling the individual tax code and now might be the perfect time to promote the issue.

President Obama’s TAX THE RICH jobs proposal officially launched his 2012 reelection campaign. His plan lacks economic substance, but the class envy card has been played successfully in past elections. The ball is now in the Republicans’ court. Just saying no to Obama isn’t good enough.

The bipartisan argument for tax reform is simple. The system has become a tool for income redistribution with one-half of Americans paying no income tax at all. Meanwhile, the wealthy face punitive tax brackets and must game the system of tax incentives and credits to keep their taxes at a reasonable level.

But the best argument for major tax reform is one that is rarely articulated: Every tax deduction at the individual or business level represents costly social engineering that requires a higher tax rate to offset the negative effect on revenue. For example, the corn ethanol subsidy has diverted corn stock from consumption to fuel production, thereby raising the price of corn, poultry, and other commodities, all in the name of a green economy. Even the popular mortgage interest deduction encourages each of us to purchase more expensive homes that we should and pass along part of the cost to our neighbors, while they do the same to us. This was a contributing factor to the mortgage meltdown and has left the U.S. with an overstock of homes, thereby lowering prices.

Some of those who constantly seek government meddling via the tax code may have good intentions, but they never seem to account for the unintended consequences of their action. Removing most of the government intervention from the personal tax code is a winning proposition (I’d prefer all instead of most but this might be politically unfeasible at the moment). While most of us benefit from one or more “tax breaks,” we are paying for countless others in the form of higher rates, as all of this is a drag on the economy.

I won’t go deep into specifics here in the interest of space. Suffice to say that I prefer a national sales tax (not a VAT) as a replacement of the income tax system, but a relatively flat income tax system might be a necessary first step to get there. A single rate is best, but two rates might be needed for political reasons. Just brainstorming, Americans at income levels under the poverty line might pay nothing, but wealth redistribution schemes such as EITC would be eliminated; nobody gets a “tax refund” in excess of what was withheld in the firs place. All income above the poverty line could be taxed at a single rate with only a few deductions such as charitable contributions. Americans with income above the 90th percentile could pay an additional 10% on that portion of income. I’d prefer something even flatter than this package, but some compromise will be inevitable.

Of course, a tax overhaul is no substitute for spending cuts. A more effective and efficient system is a definite plus for the economy, but it won’t magically produce the additional revenue needed to finance the current state of leviathan. But serious spending cuts don’t stand a chance with Obama in office and will have to wait until 2013 pending election results. Many Democrats are open to the idea of tax reform, so now is the time to put an aggressive proposal on the table.

12 thoughts on “Overhauling the tax code

  1. I received a long email from a Cain supporter asking about his 9-9-9 proposal. I like Cain and I think his idea has a lot of merit; it would certainly be a major improvement to what we currently have. I don’t officially endorse it for several reasons: (1) I haven’t seen the analysis in terms of revenue generation, (2) it adds a national sales tax (fair tax) BEFORE it eliminates the income tax, (3) it appears to fold social security into the general revenue scheme making it a permanent wealth transfer scheme, and (4) I have serious concerns about the prebate provision in the fair tax proposal. Overall, I think we could work through these issues and move in this direction, and I applaud Cain for making a serious reform proposal.

    1. Davidson: Concerning (2), Cain wants to phase in a fair tax, which admittedly has some advantages over shifting to it immediately. However, part of the phase-in leaves us with TWO major taxes, one on income and one on sales. My fear is that the phase-in will never occur and the percentages in both will grow. Europe has both income taxes and a VAT.
      Concerning (4), the fair tax proposal (Boortz/Linder) includes a “prebate” that sends a monthly check to everyone equivalent to the estimated taxes that would be paid on the essentials. The idea is that those at the poverty line would break-even and not end up paying anything. The prebate levels discussed in the proposals are pretty sizeable ($559 per month for a family of 4) and it really constitutes wealth redistribution. I understand the prebate concept and favor the fair tax proposal overall, but I don’t like the prebate mechanism. I’d rather see food, healthcare, and/or housing exempted instead. I could live with a prebate, but only if income taxes were abolished.

  2. At least Cain is putting good ideas on the table. He can’t win, but he’s pushing others to be more specific and bold. What about VP?

  3. none of this matters. obama has the republicans in a choke hold. all of them are defending tax breaks for the rich that even buffett doesn’t want. 2012 is the rich vs the people. the people will win again

  4. I agree that taxes need to be overhauled and in a major way. As an independent contractor, I almost feel guilty earning $75,000 before expenses and being able to take advantage of the current tax code to pay no taxes, or very little in SE tax. But, that’s the system and it is definitely broken. I like Cain and I support many of his ideas. However, the list is growing longer everyday of major agencies and government programs that need to be overhauled. It appears that we can’t get one thing changed or fixed; not one.

  5. Great analysis in the original post, as always, John. I have been an advocate of the FairTax for nearly a decade now, and can attest that it took me a while to warm up to the prebate. Perhaps I can help alleviate some of your concerns with the prebate, next time you come on my show.

    To the (non)point raised by “democrat” here in the comments: What “tax breaks for the rich” are you referring to? The ones we call “loopholes” for them, but “deductions” for everyone else? And what tax breaks are you speaking of that Warren Buffett “doesn’t want?” He’s engaged in a lawsuit right now, to avoid paying a BILLION dollars in back taxes. That alone should tell you that he absolutely wants every tax break he can legally take (and then some.)

    One final question, “democrat” – how can 2012 be about “the rich” versus “the people?” Aren’t “the rich” PEOPLE? Every last dollar of wealth that is held in this country is held by individuals. Last time I checked, individuals are people, no matter their net worth.

    Ask yourself an honest question (and TRY to give yourself an honest answer) : When you’ve won your little class war, and achieved your egalitarian ends, will the society you’re left with be worth living in? None of the other attempts, throughout human history, have ever produced anything more than equally shared misery.

    Oh, AND huge piles of corpses.

    Face it, chum: your ideology has failed. Always. Everywhere. What’s the definition of insanity? Yeah…

  6. hey BR, this is not about communism. nobody wants that. we want the best of socialism and capitalism in a single system. we can do this right if we are smart. let people run companies and make money but redistribute the excess to those who get screwed by the system. its about fairness. everyone wins.

  7. Democrat – problem with your blend of systems is that when it doesn’t work (which it doesn’t – case in point: that last decade), it is always because in the minds guys like you, we have too much capitalism and not enough socialism, never the other way around. So the relentless, insidious march toward socialism progresses and society goes down the tubes.

    Here’s the recipe for not getting screwed by the system:
    1. Get an education.
    2. Get married, then have children.
    3. Work hard.
    4. Make good decisions and don’t commit crimes.
    5. Learn to accept the idea that some people are luckier, more talented, smarter and more ambitious, thus will achieve more wealth in a free society. Fair? maybe, maybe not. But it is human nature. This is a great country where even the poorest among us have luxuries and safety nets the truly poor in other countries only dream of.

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