Fixing The Tax Code

Let’s talk taxes.

Everyone says we need fundamental tax reform.


I prefer The Fair Tax, but recognize that many others do not.

But what if we don’t want to do The Fair Tax?

Let’s look at a clean, progressive and simple tax instead.

We’ll use two basic metrics – the first is that the median household income is approximately $50,000.  The second is that the gross PCE (personal consumption expenditures) is, as of the present time, approximately $10,656 billion (that is, $10.7 trillion) and residential investment (that is, personal spend on residences) is approximately $330 billion, for a total of $11 trillion (out of our $15 trillion GDP.)

Therefore, let’s presume the following:

  • Three tax brackets: 10%, 20% and 30%.
  • NO deductions of any sort, and no “zero” bracket.  Everyone pays from dollar one.
  • NO other federal income taxes.  That is, payroll taxes are subsumed in these rates.  We quit pretending that FICA and Medicare are some sort of “lockbox” when in fact we know damn well they’re not.  FUTA and other “parasitic” federal taxes on employers and persons are also eliminated.
  • Long-term capital gains are only personal and at-risk investments held for three years, excluding carried interest or other “combined-risk management activities”.  These qualified capital gains are taxed at 50% of your marginal rate and accreates after ordinary income.  In other words, if your cash income puts you into the 30% bracket, all of your long-term capital gains are taxed at 15%.  All other income is taxed as ordinary income including carried interest.

Now let’s look at the BEA’s personal income tables.  They disclose that we have $8.23 trillion in employee salaries, $1.60 trillion in supplements (that is, the current payroll taxes), $1.11 trillion in proprietor’s income, $397 billion in rental income and $2.345 trillion in transfer receipts (payments from government social insuance payments – all of which are taxable since we exempt nothing.)

This totals $13.68 trillion in money and transfer receipts.  The remainder ($1.8 trillion) is receipts on assets – that is, capital gains.  I’ll presume that half of that would qualify for long-term treatment (which is probably way, way too high – today – but won’t be in the future with these changes.)

Unfortunately Census and the BEA only has quintiles through 2009.  It is what it is, but we’ll use what we can get.

We count 121 million approximate household units according to Census.  Unfortunately Census only accounts for money income – they claim (as of 2009) $7.596 trillion in total!  That’s crap, so let’s fix it – we’ll bump all categories by 64% (to account for the difference as of 2009 BEA GDP tables), since we’re taxing all income with no deductions of any sort (including Social Security and similar transfer payments.)

We will break the tax percentages as follows:

  • First and second quintile (through $35,598) are taxed at the first rate (10%)
  • Third and fourth quintile (through $93,784) are taxed at the second rate (20%)
  • The top quintile pays 30%.

All are marginal rates and quintile breakpoints will be adjusted annually.

Note that since all other federal payroll and similar taxes are eliminated those in the first two quintiles pay less than what they pay today in payroll taxes alone, but there are no refundable credits.  That is, everyone pays something, most-specifically for those social programs everyone thinks they’re “entitled” to.  In addition, the progressive nature of the tax code is retained and for most people through the bottom three quintiles they will pay less.  The exception is those who are getting a “free ride” from refundable credits – they will pay something, but only to the extent that their “free ride” ends, and in fact their burden will not exceed that which would be paid only in payroll taxes alone.

So the first bracket earns $238 billion and the second $657 billion, for a combined $895 billion (adjusted $1,467 billion).  They will pay $147 billion in income tax.

The second bracket earns $2,887 billion (adjusted $4,735 billion).  There are 48,376 such households; on the first $1.722 trillion they will pay $172 billion in income tax, and on the remainder ($3,013 billion) they will pay $603 billion, for a total of $775 billion.

The third bracket makes a lot of money.  There are 24,196 such households.  They earn on average $157,631, for a total $3,808 billion (adjusted $6,244 billion).  On the first $861 billion they will pay $86 billion in tax, on the next $58,186 in income (or $1.41 trillion) they will pay $282 billion in tax and on the remainder ($3,973 trillion) they will pay $1,192 billion in tax, for a total of $1,560 billion.  That’s a shitload of tax; on a per-household basis they pay four times the “middle income” people’s burden and ten times the bottom two quintile’s burden.  If this isn’t progressive enough for you then you need to replace your brain with one that actually works.

Oh yeah, this totals $2,482 billion in taxes on incomes.

If we assume that most of the $1.8 trillion in returns on assets goes to the top marginal rate, and half is accountable as long-term capital gain, then we have ($900 billion * 15%) + ($900 billion * 30%) = $135 + $300 billion, or another $435 billion.

We thus have $2.917 trillion in tax revenue.

Oh, this understates the revenue, since according to BEA the numbers are somewhat better than this today, but we’re using 2009 figures.  If you want to be entirely accurate you can add about 10-15% to those numbers, but I like being conservative and recognize that we have an economic adjustment to take – so I won’t.

There are no taxes on corporations under this flat tax and no deductions of any sort.  Your tax return fits on one sheet of paper, except for stock trades and such where you must show basis and acquisition date.  The Internal Revenue Code fits within a dozen pages of legislative-laid-out text.

The Federal budget, as of 2005, was supportable in full at this level of revenue complete with our current interest payment requirements and a a hundred billion or so of actual debt retirement.  Since the goal is to actually retire debt we will drop spending to 2003 federal spending levels, which totaled $2.160 trillion, effective this September.

As the debt is retired (it will take 20 years) we can advance spending by the amount of the interest on the retired debt.  You now fix Health Care using the formula I’ve previously put forward, and index Social Security over five years to the actuarial improvement in life from the inception date of Social Security to today.

Problem solved.

You want a monster economic recovery?


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