Taxing all income the same opens the door to a far-reaching revolutionary reform. Under the single-rate FreedomTax, the tax will be levied, collected, and paid at the source of payment in the case of many forms of income – dividends, interest, salaries and wages, and retirement income. This income will not require any tax return reporting. Recipients of this income never will have to file a tax return with the IRS again. For most Americans, paying the income tax will be as easy as paying the federal motor fuel tax at the pump.
By James K. Jeanblanc l December 13, 2016
The income tax is in a horrible mess. It’s insanely complicated. It’s laden with tax-spending provisions undermining its revenue-raising purpose. The tax base is badly-eroded, forcing high tax rates which, in turn, impede economic growth. It’s a sadistic tax, punishing taxpayers with heavy compliance burdens. And, perhaps most damning, the system is terribly inefficient, costing the Treasury billions to administer and requiring a mid-sized city of IRS workers to run it.
There is no shortage of tax reform proposals. The common theme is to curtail the existing tax breaks, have fewer tax brackets, and reduce the top rates.
Some of these plans would add new tax breaks of their own. Aside from adding new tax credits and exemptions, there’s a proposal to allow business investment to be expensed, rather than capitalized and depreciated over the life of the investment. This new tax break would be a stark departure from generally-accepted accounting principles used to determine income. The addition of new tax breaks serves as a beacon for the later addition of more tax breaks, particularly in a climate where tax rates are left still too high.
Proposals euphemistically claimed to be “flat-tax” plans usually are single-bracket proposals, not proposals for a flat rate on all income, and hence cannot be regarded as true flat-tax plans. By definition, a true flat tax is a proportional tax applying to all income at the same rate without deductions, exclusions, and exemptions.
Some of these plans leave the top marginal tax rates still at confiscatory levels (well over 20%), a bad tax regime if the goal is not to encourage the addition of more tax breaks and, in turn, higher rates later.
But, these are not proposals for real and lasting income tax reform. Rather, they are tax-symptom reform plans only to ameliorate this and that tax complaint. They are not plans for fundamental reform to change the nature of the income tax and how the system functions.
Most people still cling to the notion that we have an income tax when that’s not the case. Yes, the tax comes with the “income tax” label and income is used as a base upon which to compute the tax. But, this does not make it a true tax on income.
We have a person-tax system. And, person taxation is the root growing the tax mess.
The drumbeat that the rich don’t pay their “fair” share and other persons pay too much, is a confirmation that, deep down, most people accept the income tax as a person-taxing system. Indeed, tax reformers even couch their proposals on the basis the tax system is about taxing persons. Their proposals typically come with schedules showing how persons would be impacted.
The tax system functions under the self-assessment model of taxation. Taxpayers universally are required to file personal tax returns every year with the IRS, to report all of their income, to claim their personal and special tax breaks, and to compute (using their applicable tax-bracket rates) and pay the tax owed. The tax is assessed against the person filing the return, not income.
This model of taxation has been the enabler for the turning of the income tax into the something-else tax system of today. It’s the vehicle for the granting of tax breaks and basing those tax breaks upon the filing person’s status, circumstances, and even with regard to how that person might spend or invest the income. It’s the model of tax brackets and for varying the rate of taxation person-by-person.
Clearly, there’s something terribly wrong in the design and structure of any tax system purporting to tax income, where vast amounts of income escape taxation and it’s rare to find the total income of any two persons taxed at the same effective tax rate.
If Other Taxes Were Self-Assessed
Regarding the nefarious nature of person taxation, consider the federal motor fuel tax, a simple tax levied on gasoline purchased and collected at the pump. Now, it’s a simple tax, having no perceptible IRS involvement. If it were to be converted from a tax collected at the pump to a self-assessment tax on the motorist, the efficiencies would end. Every motorist would be required to file an annual “Personal Motorist Return,” reporting all gallons purchased and computing his fuel tax owed for the year. Imagine the new record-keeping required of all motorist taxpayers, and the many who would be struggling to prepare and file their personal tax returns and to pay the tax due.
And, requiring all motorists to file personal motoring tax returns would give Congress and the IRS a power over motorists not now present. Congress likely would move away from having a single tax rate on gallons purchased and could add graduated tax brackets to tax heavy users at higher rates, if their annual gallons reported on the return exceed “fair” levels of motoring. Also, it would be possible to create special fuel deductions for car-pooling and trips to see the doctor or in service of a charity, etc. And, in the case of motorists driving luxury or gas-guzzling vehicles or who do too much recreation-driving, there could be special rules imposing higher tax rates on their fuel purchases, but for those driving “green” cars or even American-made cars, they would have a lower fuel tax rate. So, person taxation and its mandated personal tax returns is the breeding ground for tax complexity and the divergent tax treatment among taxpayers.
Lesson to Be Learned
The aftermath of the Tax Reform Act of 1986 (the last major income tax reform measure) provides a cogent lesson. Addressing the tax complaints of that time, the 1986 Act curtained tax breaks, reduced the number of tax brackets, and dramatically lowered the marginal rates. But, in making those reforms, it retained the person-tax model of taxation, the very same path to be taken by the recent plans.
Left in place in 1986, person taxation allowed easy implementation of later ad hoc changes, increasing the number of tax brackets, imposing higher marginal tax rates, and expanding the tax breaks – and a return in spades to the tax mess of today.
Be warned, person taxation is the system of the tax establishment, and professional politicians and tax lobbyists can be expected to argue strenuously against this lesson and building upon it.
Building upon the Lesson
In addition to junking the person taxation model, the income tax itself must be conceptually refocused. It must be redirected from persons being targeted for taxation to making income the sole focus of tax. This means uniformity of income taxation must be made the governing principle of the income tax system.
This uniformity principle calls for all income to be taxed, and all taxed the same. Incompatible with this principle are income exclusions, tax breaks, special tax rules, tax brackets, add-on taxes, and the taxing of business income separately at different rates from non-business income. The uniformity principle makes possible a true income tax – low-rate and pro-growth, greatly simplified, compliance-easy, and tax-efficient, all resulting in a massive downsizing of the IRS.
The FreedomTax is the only proposal for real and lasting income tax reform. It would junk the person taxation model. All income would be taxed the same and at a low 10% flat rate regardless of payor, recipient, or income type. The FreedomTax is intended to raise the same revenue for the Treasury as the existing income tax system replaced. All income would bear its fair share of the income tax burden.
The FreedomTax, having a dramatically lower rate of taxation, will spur savings, investment, and job growth without need for special tax breaks. It will bring 21st-century tax efficiency saving the Treasury billions in tax administration cost and avoiding the billions in uncollected taxes.
Other proposals carry an admission their tax rates are still too high when they come with tax breaks. This explains why so many insist that income tax reform proposals must retain certain deductions, such as for home-mortgage interest and for charitable contributions, to be acceptable. But, that’s not the FreedomTax , which would establish a low single-rate tax system of 10% across-the-board, making the argued-for deductions, if retained, of much less value to the taxpayer than under high-rate proposals.
Taxing all income the same opens the door to a far-reaching revolutionary reform. Under the single-rate FreedomTax, the tax will be levied, collected, and paid at the source of payment in the case of many forms of income – dividends, interest, salaries and wages, and retirement income. This income will not require any tax return reporting.
Only business income, the net income after business expenses, would be tax-return reported. And, the low-rate FreedomTax would bring about major tax simplification and end tax-driven decision-making.
The GOP’s “A Better Way” plan promises that families would only have to file a simple “post-card” tax return in which the taxpayer merely lists the totals of his income items and claims his tax credits. But, this promise rests on the false hope that, later, the IRS would not require more to be filed, such as it does today.
Recipients of this income never will have to file a tax return with the IRS again. For most Americans, paying the income tax will be as easy as paying the federal motor fuel tax at the pump.
James K. Jeanblanc is a CPA and Tax Counsel to the law firm Grove, Jaskiewicz & Cobert in Washington, DC. He is also Senior Fellow for Tax Policy at the Selous Foundation for Public Policy Research and a contributor to SFPPR News & Analysis.