Our government is broken. I’ve written a bunch of posts on US government policy but I haven’t put forth many specifics. That’s going to change. This is the first post in a series about how I’d fix the US. Potential political career disclaimer: I reserve the right to change my opinons when presented with new evidence. That’s what smart people do. That doesn’t make them a flip-flopper.
At nearly 75,000 pages and growing, nearly everyone agrees the tax code is broken. But US taxes are one of the most controversial and yet least understood parts of our government. In order to fix our debt problem, we need to address revenue and spending. Anyone who says we can fix our problem with one or the other is just not credible. My plan would raise a bit more revenue for the government and make it more fairly distributed to US citizens. I fully understand it would never pass.
At 75,000 pages only those with massive incomes can afford to pay lawyers and accountants to legally evade taxes. My Dad is an attorney and he struggles to make sense of his rather simple tax return. I’ve been assessed penalties by the IRS three times for honest mistakes on my business taxes.
Complexity is why people making $100m a year use offshore accounts and those making $75,000 don’t. It’s one of the reasons Warren Buffet pays a lower percentage in taxes than his secretary . Facebook can afford to take advantage of the rules to save itself money. Complexity helps the rich and sophisticated at the expense of the rest of us.
We also waste billions of dollars trying to enforce our byzantine tax code. Not to mention the millions of man hours per year.
Although nearly all of the attention gets focused on the income tax rate, it only makes up 42% of all US Federal tax revenue. We have massive fights over the income tax, but what about the other 58%? Our income tax is progressive, but most of the rest of our taxes are regressive and hurt the poor over the rich.
Promote Investment not Speculation
Our current tax code doesn’t really differentiate between speculation and investment. Our biggest problems have come from speculation at the expense of investment. My tax code gives you promotes investment in our future.
1. Income Tax
Our 75,000 page tax code could be simplified to four sentences. Our tax return could be simplified to a post card.
My income tax would have three brackets, 5%, 25% and 35%. The first $10,000 would be free. I’d eliminate all tax deductions. Brackets would be set to get similar revenue to what we have today, plus a bit more to cover our shortfall.
2. Payroll Tax: Social Security, Medicare Tax & Self Employment Tax
I would completely eliminate the payroll tax and raise income tax rates and eliminate deductions to get more revenue from income taxes. Income taxes and reduced deductions would have to rise greatly because payroll tax accounts for 40% of federal revenue.
The payroll tax and self employment tax are two taxes taken out of our paychecks. 15.6% of our paycheck goes to the government to pay for Social Security and Medicare. If you are an employee, you pay half out of your paycheck and your employer pays the other half. If you work for yourself, you pay both halves. This tax is poorly designed for three main reasons.
First, it disincentivizes entrepreneurship and self employment.It punishes self employed people and entrepreneurs. We have to pay 15.6% of our income to the government, whereas an employee only pays half of that. Second, it discourages companies from hiring. Companies are required to pay 7.8% of an employees salary in taxes when they hire them. That’s not good for an economy fighting through high unemployment. Third, it’s incredibly regressive. It only affects the first $100,000 of income, meaning that if you make $400,000 in a year, you only pay an effective rate of about 4% while a self employed person making $40,000 pays the full 15.6%.
3. Corporate Taxes
Flat rate of 10% on all corporate income. No exceptions.
This change would lower the burden on small corporations that are currently paying 15-35% and increase the burden on the biggest companies like Facebook, GE and others who pay 0% because they’ve hired expensive attorneys and accountants to shirk their burden with tricks like the double irish.
4. Dividend income and Interest Tax
10% flat rate on all income from dividends and interest. This income generally comes from money that’s already been taxed from income or other investment taxes, so it’s not fair to tax again at a high rate. It’s also counter productive.
5. Carried Interest
Taxed as normal income.
This is the odious loophole that hedge funds and bankers use to pay 15% taxes on their billions in income each year. It should be a crime, but our government is unwilling to make changes. This is probably the most unfair tax on the books. VCs currently benefit from it, but under my plan they’d go into capital gains since they are investing.
6. Capital Gains Tax
In year one, you pay your income tax rate. In year two, it’s your rate minus 5% points. Year 3, minus 10% points. In year 5 you pay 0%.
Capital Gains are money that you make investing in stocks, companies, real estate and other things that you later sell at a higher price. The current system is you pay income tax rates in year 1, then if you wait more than a year, you pay 15%. The goal is to incentivize risk taking and investment, but holding a stock for one year is not enough. An investment is long term and you should get big benefits if you really invest for the long haul instead of speculating with an under two year time horizon.
7. Estate Tax
25% on all estates over $7.5m.
This is one of the most debated taxes right after the income tax, but it only affects 13,000 estates per year. When someone dies and their total assets (property+investments+cash) is over a certain amount, the estate must pay taxes. The goal is to eliminate family inheritance of billions that create an idle rich class. Many say it’s unfair to double tax the money because it’s already been subject to income and investment taxes while the person was living, but I don’t believe so. 25% on all assets above $10m, indexed to inflation, is fair.
I have not done all of the math to make sure that my rates make sense. If they are too low to get our current levels of revenue, I’d increase the income tax rates. If they are too high, which I highly doubt, I’d reduce them. The goal of this post was to create a framework that makes sense to simplify our tax code and make it more fair.
What do you think?