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How to fix the tax code: The 12 percent solution

buslermichael041211_optBY MICHAEL BUSLER
COMMENTARY 

As we attempt to solve the fiscal cliff problem, most agree that we need to increase tax revenue. But that needs to be done in such a way that it is not harmful to economic growth. Is that possible?

It may be possible, but not by simply tweaking a few rates. What is necessary may be a complete overhaul of the federal income tax code to make it 1) more equitable, 2) more efficient, 3) easier to administer and 4) increase tax revenue. The current income tax code likely fails all four of those measures.

The current code is viewed as not equitable (fair) since Mitt Romney and Warren Buffett pay a lower tax rate than their secretaries and many large multi-billion dollar corporations pay no income tax at all because they relocate their headquarters outside of the U.S.

The current code is not efficient since tax loopholes reduce tax payments as long as the income is earned or spent in a government favored market. The current code is extremely difficult to administer since the 300 million words in the tax code are never fully read or understood by anyone and the current code does not raise enough revenue to come close to balancing the budget. Is there a better idea?

Here is a solution that addresses all four concerns. Replace the current complicated and counter-productive tax code with this:

A 12 percent single rate tax on all income above a livable minimum (say the poverty level) with absolutely no deductions for anything. All income is taxed at the same rate, no matter how the income is earned or how the income is spent. All income from wages and salaries, rent, interest, dividends or capital gains will be taxed at the 12 percent rate. Corporations pay the 12 percent rate on all income. This proposal satisfies all criteria.

This proposal is fair and equitable. Every income earner pays exactly the same rate on all income earned above a livable minimum. Wealthy people will pay more tax dollars but proportionately the same as everyone else. So Romney and Buffett pay the same rate as their secretaries.

For some reason, many people believe that higher income earners should not only pay more tax dollars but should pay a higher rate than others. This does not seem equitable. If the wealthy pay the same percentage, they will pay more dollars as their income increases. But they pay proportionately more, not disproportionately more. That seems fairer to me.

This proposal is very efficient since it does not favor nor discourage any method of earning income or any method of spending that income. No distortions are created in any market. So a person who chooses to rent a home is treated exactly the same as a person who chooses to own a home with a mortgage, thereby not distorting housing prices. (Some economists believe that the current tax system contributed to distorting housing markets so that the financial crisis resulted.)

This proposal is extremely easy to administer. An individual simply adds up all of her income from all sources. Then the livable minimum is subtracted. The balance is then multiplied by 12 percent and that’s the tax liability. It is a one page form.

This proposal will raise more revenue. Last year the personal federal income tax raised about $1.1 trillion in revenue. This proposal will would have raised more than $1.3 trillion. In addition, this proposal will add to economic growth. A number of studies have been done examining the relationship between tax rates and economic growth. These studies have concluded that lowering the tax rate and switching from a progressive tax to a single rate tax would add significantly to growth in real GDP. That means more people would be hired so that the unemployment rate would fall and there would be more people paying taxes. This too leads to increases in tax revenue.

Some will argue that this proposal is really a tax cut for the wealthy. But it really isn’t, since the wealthy pay about this rate anyway because most of their income is taxed at the currently low rate for dividends and capital gains. The wealthy would be encouraged to invest more (since all marginal income is taxed at only 12 percent) and they will likely earn more taxable dollars, contributing to more tax revenue for the government.

While this may seem like a simple solution to a complex problem; sometimes simple is better.

Michael Busler, a public policy analyst, is an Associate Professor at Richard Stockton College.

 

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