The Amateur Financier

Welcome again to another session where I take on the role of Benevolent Dictator (although, not the one you learned about in Economics 101) and attempt to solve all the problems of the country in the course of a few blog entries.  This week, we’re going to look at one of the most hated, cursed, and generally despised aspects of life, as well as the only one that ranks up with death in terms of inevitability.  That’s right, this week I take on taxes!

Just about everyone believes that some level of taxation is needed, to fund the vital roles that various levels of government play in our lives; the problems arise when it comes down to who should pay those taxes, and how much.  If you do enough reading, you’ll see that everyone has their own view on how the tax system should be structured; income taxes to sales taxes, capital gains taxes to the Fair Tax, flat and progressive taxes are all thrown out by one group or another in an attempt to fill our coffers.  Going through every single proposed tax plan, discussing its pros and cons could fill weeks worth of posts, or even an entire blog.  Instead, for this exercise, I shall use my powers to cut through all that and get down to the basics of what would be in MY tax system.  The guiding principles I’m going to follow are that an ideal tax system should be:

1) Simple – The perfect tax system should be so simple that you can fill out a return on a single sheet of paper, with all the instructions included.
2) Progressive - Those who make more money should pay an equal or higher percent in taxes when compared with those who make less.
3) Controlling Disincentives – Unfortunately, taxes distort economic incentives.  Income taxes make earning an income less appealing, sales taxes make buying things less appealing, and capital gains taxes makes selling economic products less appealing.  The goal of a tax system should be to keep these disincentives to a minimum, or direct them towards decreasing the incentive for negative behavior.

With these principles in mind, what would be my ideal tax system?

My Solutions

A Graduated, Gradually Progressive Income Tax – The basic structure of the new tax system will be essentially an almost-flat income tax.  Almost because, to ensure that our tax system remains progressive, those earning a higher wage should a higher percentage in taxes on the last dollar of income than someone earning less.  A five to ten percent differential between each tax bracket (and a limit of only three or four brackets) will ensure that moving from one bracket to another won’t dramatically increase the taxes you pay on that last dollar of income.  There will be arguments that this creates a disincentive from earning more money, but if all the ways of making an income are taxed according to the same rates (in my mind, ranging from 10% to 40%), the discouragement will be minimal.  And speaking of which…

Tax ALL Income According To the Same Scale – One of the major sources of confusion and bad financial decisions when it comes to taxes is due to the numerous different types of income.  Short term capital gains are taxed at a different rate than long term capital gain, money you inherit is taxed differently than money you earn by working, and of course, if you make a high enough amount of money working, you might have the Alternate Minimum Tax to handle, as well.  The simplest way to deal with all those different systems is not to deal with them at all; treat all income as well, income, and tax accordingly.  The system will be simplified, tax incentives to act irrationally will disappear (such as holding a declining security to get the long term capital gains tax rate, even if it declines to zero), and no more finagling of HOW you get paid to lower your tax rate will be possible.

Eliminate (Almost) All Deductions – Another problem with the current tax system is that it has, over the years, become so chock full of deductions for dozens of different reasons.  Whether it’s trying to encourage homeownership, increase investments, or help people who have kids to have a little extra spending money, there are a huge number of tax deductions and credits in the current system, as you can see from this About.com list.  The easiest way to cut through all the bull honky is to eliminate all of the deductions and just add back in the few that are the most common (and popular): retirement accounts, children and mortgage interest payments will be among these selected few.  Such eliminations of ‘loopholes’ will enable taxes to be lowered all around.

Make the Tax Rates Public, Flexible, and Tied to Government Spending – If you remember last week, I railed about how I would change government budgets. Here’s another step in that plan: when government spending rises, taxes rise.  If the Federal Government wants to spend more money, rather than adding to the national debt (which, as you may recall, we will now be regularly paying down), taxes will automatically rise to a level consistent with the new budgetary needs.  Unless otherwise specified in the bill, the increase will be across the board, covering everyone from the lowly minimum wage earner to the multi-millionaire living off dividends.  If having everyone in the country watch their tax rates rise to cover new spending doesn’t make politicians think twice about adding more programs without first ensuring that they won’t add on more debt doesn’t slow them down, nothing will.

There you have it: my four step plan to a simpler, saner tax policy in the United States.  Feel free to nominate me for the Noble prize in economics, if you so desire.

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