Thursday, November 15, 2012

My Ideal Tax Plan

It's highly likely that some time this year, Congress will come to an agreement on taxes. And it's almost certainly not going to be as efficient as it should be.

The Democrats want to let the Bush tax cuts expire. The Republicans see the writing on the wall but they don't want to raise nominal tax rates. Any likely deal will probably keep the Bush tax rates but limit deductions for high income households to raise the additional revenue that the Democrats want to extract from the rich.

We're going in the right direction, but it's still going to be distorted. The problem is our tax code contains so many ways to reduce your tax liability through credits and deductions and special interest groups will fight to the death to protect their own loopholes. But if we could rewrite the tax code from scratch, I'd like it to look something like this for individuals

Payroll taxes: None. That means FICA gets eliminated.

Ordinary tax rates:

15% on the first 60k
25% on any dollar over 60k

Passive income tax rates (long term capital gains, dividends, and interest):

0% on the first 60k
15% on any dollar over 60k

Deductions: Charitable contributions only

Credits: An earned income tax credit worth up to 6k dollars on the first 25k dollars worth of income. (If you have children, you're entitled to 6k from the Federal government as long as you make less than 25k per year but more than 8k). Any dollar amount you make over 25k gets subtracted from the 6k. For example, if you make 27k per year, then your EITC is only worth 4k. (27-25=2, 6-2=4)

All figures are using 2012 dollars and will be indexed for inflation via the CPI for future years.

You might be wondering why I chose these numbers. And it's very simple: transparency and "fairness".

As surprising as it may sound, if you make over 60k per year, that puts you in the top 20% of full time workers in the US workforce. Over the past year or so, we've heard a lot about the 99% and the 1%, but the fact is the biggest socioeconomic divide is the gulf between the upper middle class and everybody below them.

The greatest upward social mobility in absolute dollar terms exists in the upper middle class. Because it's the college educated entrepreneur that is most likely to become a billionaire. So people who are in the upper middle class should pay each additional dollar at a greater rate than what everybody else pays. The reason why I don't have a higher rate for "millionaires and billionaires" is because I believe that the opportunity for uber-wealth is more or less equal among any given individuals in the upper middle class.

If you're college educated, make a decent amount of money, and have a good idea, you can make a ton of money. Whether it's chance or sheer dint of will that you made it big (and I'm excluding lottery winners, celebrities, and athletes), your fortunate position was fundamentally derived from being educated, not lucky.

And these rates are most likely to be accepted by a majority of Americans. An impressive majority of Americans don't believe a person should give more than 25% of their income to the Federal government. But they're for higher taxes on the rich precisely because they don't think the rich are paying at the top marginal rate because of the ridiculous number of tax loopholes. By limiting deductions only to charitable contributions, it easily disabuses the notion that the rich aren't paying their "fair share".

And by having the top passive income rate at the same rate as the middle class rate, it prevents a "Mitt Romney situation" where a billionaire could have a lower effective tax rate than a middle class family. Because we've eliminated payroll taxes (which are regressive), it becomes impossible for a billionaire to have a lower percentage tax burden than a middle class family unless he gives away a significant amount of his income to charity, in which case the populists in American politics can't attack him for it.

This, I think, represents the "fairest" tax code from any reasonable perspective. And I think, if explained properly, the vast majority of Americans would accept this plan. The best part is that it raises roughly the same amount of revenue, and it still contains a significant provision to prevent families from falling into poverty.

The only real downside is the army of unemployed tax accountants that will result because of this. But hey, sometimes you gotta crack a few eggs to make an omelet.


  1. I'd scrap the capital gains tax for a VAT and raise rates for the wealthy to make up for the loss of progressiveness.

  2. Probably with another tax bracket.