Yet more tax increases

Yesterday, the White House announced a deficit reduction package that includes a mixture of spending cuts, mostly on non-defense discretionary domestic spending and letting the Bush-administration tax cuts expire. The package does reduce the deficit by some amount over the next 10 years, but the deficit, even with these proposals will still be staggering, totaling trillions of dollars. Most of us know what a trillion dollars look like on a piece of paper, the number '1' followed by 12 zeroes; but to actually be able to incur a deficit that large and still be in business is mind boggling.

Yesterday, I closed my doors with a mere $5000 in debt. Sure, it would be nice to be able to stay in business and run up my debt to $1,000,000,000,000; but no bank would ever allow me to do it. Why do creditors allow the US government to do it? In fact, why do we allow our government to do it? After all, we are the ones footing the bill ... eventually, when our lenders, like China, demand their money back. The knee jerk reaction, of course, is to "tax the wealthy", "tax big corporations", "tax capital gains", "tax Wall Street", "tax big bank executive bonuses at 100%", "tax cadillac health plans", etc. All these have floated around Washington, and various state capitals since the recession "officially started" in 2008.

All this rhetoric floated around by populist members of both political parties are rooted in the American desire to be fair, and many organizations have harped on the nice sounding argument that the rich don't pay their fair share. Is this really a true statement? The upper 10% of Americans pay 71% of the taxes. It is true that our tax system is not fair; after all why should 10% of the country pay 71% of the taxes? Moreover the bottom 20% pay about 5% of the taxes. These are just numbers bantered around on a blog. Let's ask how much income is the 90th percentile in income? $500,000? $250,000? Neither guess is correct. It is $113,000, which is an income level that many of our friends or neighbors have.

So raising taxes on them hasn't worked, because they already do pay the bulk of the personal income taxes. It is politically incorrect to advocate raising taxes on the bottom 20%. Yet, unless the government raises more revenue, the country really will go bankrupt. Such spending is unsustainable. While it may be true that the upper 10% do pay the bulk of the taxes, it is not necessarily true that their tax rate (on April 15 when taxes are due) is the highest. With their deductions, their rate may be lower, but since they do make quite a bit more money than the bottom 20%, they still end up paying more total dollars to the IRS.

Before advocating eliminating their deductions and let them pay taxes at their marginal tax rates which are a lot higher, how about if ALL deductions were eliminated for everybody, including corporations, and everybody pays a flat rate, say 15% to start. For many people, most of them in the middle income range, less than the 90th percentile, but greater than the bottom quintile, their taxes would actually go down. For people at the top, their tax rate may go up or down, depending upon how good their tax person is and for people at the bottom, their taxes would go up since many of them don't pay taxes at all.

Fairness is really about no exceptions; the rules are the same for everybody. Eliminating deductions, which do tend to favor the better off, puts them on the same footing as the lower quintiles, since they don't have things like houses that tend to dramatically lower tax bills. Why not exempt the bottom? After all they don't make anything. In the name of fairness. The moment you make an exception, you already created a class of people who are more "privileged" than everybody else. 15% of $10,000 is $1,500; 15% of $1,000,000 is $150,000. The total taxes paid would still be skewed in such a way that it looks like the upper 10% still pay the bulk of the taxes. The difference is that overall tax collections would increase.

Middleman take up a large part of the economy that could be spent on doing more useful tasks. Our tax code is so complicated that entire industries are spawned just to keep up with all the changes. Moreover, equalizing the tax code can get rid of the IRS and any other tax collecting agency that is part of our state governments. Or the IRS can simply be the tax collector, and manage the funds for the Treasury Department. Financial planners would probably still exist, although investment decisions would be less driven by the tax code and more driven by the market conditions. But the tax preparation arm of such businesses would no longer be needed.

It has been argued in the past that the mortgage interest deduction is at least partially responsible for escalating housing prices. That deduction is worth quite a bit. If there was no deduction, home buyers really would pay attention to the cost of the house and over time, people would not buy more house than they can afford. The tax code obscures the real value of the house and the potential buyer has no way of knowing what the house should be worth, let alone what is it really worth. Eliminating it would stabilize the housing market and generate more overall revenue for government.

The flat tax is the only way to go. If the US continues on its present course, there will never be enough revenue, because there aren't enough rich people to tax. What happens over time is the definition of "rich people" change. Soon the threshold for rich people will drop to less than $100,000. Soon it will be anyone with a job, as if job holders do not already have enough taxes to pay. It is time to rethink our tax code before we all get penalized merely because we work and if we do rethink our tax code, how about making it simpler and getting rid of the IRS as an outdated institution?