CATO: Options for Tax Reform
A18:
http://www.cato.org/pub_display.php?pub_id=3681
If you hate them all, pick the one that's least terrible.
Hall-Rabushka Flat Tax
Individuals:19% tax on wages and salariesDividends, interest, and capital gains not taxedLarge personal allowances: $9,500 singles, $16,500 married, $4,500 per dependentAll other deductions and credits eliminated
Businesses:19% cash-flow tax on all businessesCapital expensingWages are deductible, but interest and dividends are notTerritorial treatment of foreign investmentCash-flow accounting that excludes financial flows from tax base
In 1981 Robert Hall and Alvin Rabushka of the Hoover Institution introduced their flat tax proposal.
Under the Hall-Rabushka plan, wages in excess of a large personal exemption would be taxed at a flat 19 percent.
Individuals would not be taxed on interest, dividends, or capital gains because capital income would be taxed at the business level. The flat tax adopts essentially Roth IRA treatment for personal saving—wages would be taxed when earned, but after-tax earnings that were saved would accumulate tax-free. The exception is pension benefits, which would be subject to the individual tax because contributions were from pretax income.
Large and small businesses would file the same simple tax return and pay a flat 19 percent on a net cash-flow base.
Taxable cash flow would equal revenues from the sale of goods and services, less deductions for wages, materials, equipment, buildings, and other purchases.
The flat tax is not just a simple version of the current income tax. It is a consumption-based tax system because it uniformly removes a layer of taxation from saving and investment. For individuals, it does not tax the return to savings. For businesses, it allows an immediate deduction, or expensing, of the full value of new capital investment.
Retail Sales Tax
Individuals:Tax not collected from individuals
Businesses:To replace income taxes, a 17% (tax-exclusive) rate would be needed on 55% of GDP
In the 1990s Reps. Dan Schaefer (R-CO) and Billy Tauzin (R-LA) gained support for their plan to replace the individual and corporate income taxes with a 15 percent national retail sales tax.
More recently, the FairTax proposal championed by Rep. John Linder (R-GA) has garnered more than 50 cosponsors in the House. The FairTax would replace the individual and corporate income taxes and the federal payroll tax with a 23 percent retail sales tax.
House Speaker Dennis Hastert has said that he favors replacing the income tax with a sales tax or a value-added tax, and Majority Leader Tom Delay has said that he favors a sales tax but is open to other tax reform options.
The proposed tax rates of these plans are calculated on a tax-inclusive basis. That allows for an apples-to-apples comparison with income tax rates, which are also expressed on a tax inclusive basis. By contrast, state sales tax rates are usually expressed on a tax-exclusive basis, which is simply the percentage mark-up on a product. For example, a 5 percent (tax exclusive) sales tax on a $100 item yields a tax of $5. This rate is the same as a 4.8 percent rate measured on a tax inclusive basis, calculated as 5/(100 + 5). The Schaefer- Tauzin plan has a tax exclusive rate of 18 percent, and the FairTax plan has a tax exclusive rate of 30 percent. Thus, a consumer purchasing a $1,000 computer after the FairTax was enacted would pay $300 in tax. Replacing income taxes with a national sales tax has potentially large benefits. There is no doubt that a workable flat retail sales tax would strongly promote economic growth by ending the income tax bias against saving, eliminating distortions on business investment, and reducing top marginal tax rates. A national sales tax would also be much simpler than the income tax.
It is true that Congress would likely manipulate a sales tax over time to include numerous different rates and exemptions. However, that would be a minor problem compared with the complexities of the current system, which has hundreds of deductions, exemptions, and credits and different effective tax rates on every industry. Even with numerous exemptions, real-world state sales taxes have compliance costs that are perhaps only one-fifth as high as income tax compliance costs, when measured as a share of revenue collected.
Finally, a big advantage of replacing income taxes with a retail sales tax would be that the full federal tax burden would be visible to individuals. The FairTax plan would repeal the two largest hidden taxes, the corporate income tax and the employer payroll tax. Citizens would see the full cost of government every time they were at a retail checkout counter. Some analysts argue that people would have a hard time figuring out their total taxes paid under a sales tax. Economist Steve Entin, for example, says that taxes should not be hidden by being collected in bits and pieces over the course of a year as the taxpayer goes shopping, as either sales or value-added taxes.
Although taxes reported on paystubs, such as the income tax, allow people to see the share of their earnings being taxed, sales taxes have the advantage of providing more frequent reminders of the government's burden if they are noticed at the checkout counter.
A18:
Savings-Exempt Tax
Individuals:Flat rate tax of about 22% on individual income that is not saved, per IRET planLarge basic family allowancesAll saving is deducted, but all saving withdrawals are taxedNearly all other deductions and credits are ended
Businesses:No business tax
A savings-exempt tax would replace the individual and corporate income taxes with a comprehensive tax on individuals that allowed a full deduction for net saving during a year. Under such a system, there would be no need for a business-level tax because capital income would be handled at the individual level. The tax base of a savings-exempt tax would be economically similar to the base of a sales tax and the Hall-Rabushka flat tax, and it would have the same pro-growth advantages.
Dual-Rate Income Tax
Individuals:Income tax rates of 15% and 27%. Higher rate begins at $90,000 (single) and $180,000 (married)Dividends, interest, and capital gains taxed at 15% maximumStandard deduction per current law. Personal exemption increased from $3,200 to $4,500.Earned income tax credit retainedSavings vehicles, such as IRAs, retainedAll other deductions and credits eliminated
Businesses:15% tax on corporationsWages are deductible, but interest and dividends are notFurther optional reforms include capital expensing and territorial treatment for international investments
This option would reform individual and corporate income taxes by cutting marginal tax rates, creating neutrality between different income sources, and ending narrow tax breaks. The dual-rate tax would provide an incremental step toward a flat consumption-based system.
The dual-rate tax is a good model for the president's advisory panel if it wants to propose reforms within the general bounds of the current tax structure. Under this plan, the individual income tax would be turned into a two-rate tax that eliminated most deductions and credits. Individuals would be taxed at a low 15 percent rate on income up to about $90,000 (singles) and $180,000 (married) and 27 percent on earnings above those thresholds.
Currently, there are six income tax rates ranging from 10 to 35 percent. Under the dual-rate tax, the vast majority of families—roughly 95 percent—would face a low 15 percent marginal income tax rate. Under current law for 2005, singles with taxable income above $29,700 and couples with taxable income above $59,400 are in the 25 percent and higher tax brackets. The dual-rate tax would cut the marginal rate for most of those taxpayers to 15 percent. The 27 percent rate would kick in at the wage threshold at which the 12.4 percent payroll tax that funds Social Security cuts out. The effect would be to create a consistent marginal tax rate of about 29 percent on earnings of all middle- and higher-income households, taking into account both the payroll and the income tax. That would be a big cut in the marginal rate for many middle- income families, who currently face a marginal rate of about 38 to 41 percent.
For example, single earners with wages between about $38,000 and $90,000 face a payroll tax rate of 15.3 percent and marginal income tax rates of 25 or 28 percent under current law. While marginal tax rates would fall under the dual-rate system, nearly all credits and deductions would be eliminated, such as the mortgage interest deduction.
By dropping marginal rates and ending special breaks, the dual-rate tax would create a high degree of horizontal equity.
The dual-rate tax plan would retain the current law standard deduction, which is $5,000 for singles and $10,000 for married couples in 2005. The plan would also include an increased personal exemption, which would partly offset the elimination of the child tax credit. The exemption would be increased from $3,200 under current law in 2005 to $4,500. The plan would also retain the EITC, which reduces taxes for low-income workers.
The dual-rate tax would also retain pro-savings features of the current tax code, including 401(k)s, IRAs, and Health Savings Accounts. Indeed, further steps to simplify and liberalize personal savings could be incorporated into the plan.
A key goal of the dual-rate system is to reduce and equalize tax rates on income from savings. The maximum tax rate on dividends, interest, and capital gains would be set at the lower personal rate of 15 percent. (Interest is currently taxed up to the maximum individual rate of 35 percent.) To match that change, the corporate tax rate would be cut to 15 percent and net interest deductions (interest receipts less interest deductions) excluded from the tax base.
The result would be that interest and dividends would be taxed at both the corporate level and the individual level at 15 percent, for a net combined rate of 28 percent. The top combined marginal rates on wages, dividends, interest, and small business profits would be just under 30 percent in the dual-rate plan, compared to 35 to 45 percent under the current tax system.
To get the corporate rate all the way down to 15 percent and retain revenue neutrality, corporate subsidies on the spending side of the federal budget could be cut. Also note that cutting the corporate tax rate would create macroeconomic feedback effects that would offset a large share of the revenue loss.
The tax could be extended from corporations to all types of businesses.
MODU:
Of these, I would have to go with Retail tax. That way, everyone pays the tax. The other three options leave ways for the uber rich who do not pull an income to get away without paying their fair share.
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Quote from: MODU on July 16, 2005, 08:26:04 PM
Of these, I would have to go with Retail tax. That way, everyone pays the tax. The other three options leave ways for the uber rich who do not pull an income to get away without paying their fair share.
Umm, that's one of the really regressive ones.
MODU:
Quote from: jfern on July 16, 2005, 08:27:55 PM
Quote from: MODU on July 16, 2005, 08:26:04 PM
Of these, I would have to go with Retail tax. That way, everyone pays the tax. The other three options leave ways for the uber rich who do not pull an income to get away without paying their fair share.
Umm, that's one of the really regressive ones.
I would change parts of it, but of those listed, that would be a "fair" tax.
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