2012-12-11: Fix The Tax System
There are a few major issues with the US income tax system as it currently exists. No proposal, not even this one, can fix all the existing issues, even before we consider that any proposal will have effects that negatively affect some segment of the population.
Progressive Tax Systems Promote Cheating And Nonproductive "Investments"
Tax systems in which the marginal rate increases as income (or most often income bracket) increases cause people to artificially avoid crossing rate-increase boundaries. They may do this by investing in enterprises where they expect to lose money (e.g., housing developments in the middle of Alaska, drilling for oil in areas where oil has never been found before, solar or wind electric-generation projects).
These tax systems promote resentment by high-income people, as they see low-income people who pay little (or even negative) taxes continually demanding more programs. Lower-income people see tax-paid programs as having no price, since—for them—they do not have any cost.
For this reason, I propose that the first US$20K of any individual's income should be tax-free.
"Family-type" Deductions And Credits Shift Taxes Onto Single And Childless
Deductions and credits for being in an approved relationship (i.e., married or parent-child) reduce tax collections. In order to make up for that, everyone's rates must be raised. The impact of the higher rates falls disproportionately on those who do not qualify for the deductions. In effect, single, childless taxpayers subsidize married people and parents.
Likewise, reduced tax rates for couples that file jointly is yet another way to subsidize married couples at the expense of those who file singly.
The Mortgage Interest Deduction Discourages Buyers From Performing Detailed Examination Of Terms
When someone is wavering on whether to borrow money to purchase a home, real estate sales people as well as lenders' representatives will point out that borrowers need not worry about the interest, because they will get it all back on their taxes at the end of the year. However, higher interest rates are likely to be accompanied by other terms that are harmful to borrowers.
Secondly, the deduction could induce people whose situations (not counting the deduction) make home ownership a non-sensible proposition to purchase property anyway. The buyers may then find themselves hard-pressed to pay normal repairs and maintenance, plus property taxes.
After the role that financial corporations' misconduct played in our recent (and continuing) nationwide / worldwide financial situation, I certainly do not wish to encourage buyers to rely upon the glib assurances of real estate brokers & salespeople, and those of mortgage loan "consultants". I want buyers to say, "reading the paperwork, I noticed that interest rises to X.Y% after two years, and that there is a balloon payment after twenty-five years. I am not comfortable with these terms, so I will walk out if you cannot offer me better terms."
Deductions, Credits, Exemptions, Alternative Minimum Tax All Distort Tax Rates, Confuse Taxpayers
In theory, taxpayers whose income places them in the top federal tax bracket pay a marginal rate of about 35% of every succeeding dollar. In reality, they use deductions, credits, and exemptions to lower their taxable incomes and tax rates significantly. The AMT is designed to cap the impact of deductions / credits / exemptions and prevent high-income people from escaping taxation altogether. If we would get rid of these distortions, the AMT would be unnecessary, and Warren Buffett would not pay a lower overall rate than his secretary.
Corporate Loans Should Be Repaid With After-tax Profits
Currently, other taxpayers subsidize corporate debt financing. This is because loan repayment is considered an expense and comes out of pre-tax revenues. Selling stock, on the other hand, involves paying dividends out of after-tax profits. The corporation (rightly) sees it as loans being less costly than stock, when the reality is that financial leverage (e.g., loans) increases the risk that the company will have one or more unprofitable years during the term of the loan. By moving loan repayment to after-tax income, we will increase tax revenues, but we will also encourage corporations to use debt financing only when and where that makes sense.
Corporate Taxes Should Use "Unary" Systems
In some states, notably California, corporations are taxed based on some prescribed formula for deciding how much of that corporation's revenue and profit was generated because of activities within the state. A large warehouse that does not bill or collect from customers might still be as important to the company's profitability as the sales office in Ireland. Federal taxes on corporations should reflect this recognition.
Tax Proposals Will Cause Damage
The recent and current tax proposals, both those of the Democrats and those of the Republicans, are not designed to prevent the very highest income taxpayers from paying lower overall tax rates than the rest of us. This despite the fact that both Congress and the White House know that deductions caused the problems and eliminating deductions will fix them.
For instance, the "tax the rich" proposals intentionally ignore deductions and the anti-deduction we call AMT. The "business-friendly" proposals pretend that cutting services and (especially) employees will solve the taxation problem.