Sensible Tax Reform: Fair, Simple, and Effective
FAQ: Impact on Individuals
What is the personal income-tax component of Sensible Tax Reform?
With the fair-and-simple income tax on very high incomes, all income from whatever source is totaled. Then $1 million is excluded--no one will pay any tax on their first million dollars of income each year. Unlimited deductions for charitable donations will be permitted under STR. Only total annual income greater than $1 million plus all donations will be subject to any income tax. Fewer than 1% of Americans will be subject to the income tax.
Net taxable income = (Total income) - ($1 million exclusion) - (charitable donations)
Back to TopSensible Tax Reform primarily relies upon a federal consumption tax. Why is an income tax also part of STR?
Sensible Tax Reform is not simply a proposal for shifting the American federal tax system to a federal consumption tax (FCT). Rather, it is a comprehensive tax plan that eliminates most current federal taxes (e.g., Social Security, Medicare, estate, alternative minimum, business income, and most personal-income taxes). Its principal source of replacement income will indeed be the federal consumption tax. However, an FCT alone will not be sufficient.
Taxing consumption alone has several serious flaws, especially in terms of fairness. The poor spend all of the income that they receive. The middle class spends most of theirs. On the other hand, someone with $10 million or $50 million or $1 billion of income spends only a small part of their income. The poor and the middle class would thus pay a much higher effective tax rate as a share of their income than do the rich. The poor will be taxed at a 30% rate on all of their income, since they spend all of it (although they are protected by the rebate). A family with $100,000 of income would pay an average tax rate of between 20% - 30%, depending upon their ability (and willingness) to save. A family with $1 billion of income and $20 million of consumption would only be paying an average tax of much less than 1% of their income. Any tax system that taxes the poor and middle classes at much higher rates than the ultra-wealthy is very regressive. That is unjust!
America is a meritocracy--success is based upon merit. That is the philosophy of Sensible Tax Reform, but not of much of America’s current tax code. STR will make it easier for many more people to become very wealthy. Unspent income (savings) will not be taxed and can therefore be productively invested. However, at some point, if the annual income rises above $1 million, the income should be taxed. It is needed for America’s social, economic and political health. And the revenue from it will help to keep the federal consumption-tax rate lower than might otherwise be necessary.
While many of the wealthy acknowledge their debts to America and the American people, there remains a significant group that think that they should be exempt from federal (and state) income and estate taxes. They would like us believe that it is fair that they should have no income or estate-tax obligation at all--even if their income exceeds billions or if they inherit tens of billions of dollars. [Leona Helmsley, the “queen of mean,” notoriously said: “We don’t pay taxes--only the ‘little people’ pay taxes!”] That mentality is inappropriate for America --and very dangerous.
In addition, the income gap and the wealth gap in this country are growing very rapidly. This is increasing economic tensions, social tensions and political tensions. Of special concern is the political influence of the ultra-wealthy who wield a very strong influence on our national and municipal governments. We are risking the creation of a plutocracy--an economic aristocracy.
In America, there is an unparalleled environment for individuals to amass great wealth. The hundreds of thousands who have become wealthy through their own efforts deserved the right to do so. However, they did not earn their wealth in a vacuum. There is nowhere else on the face of the earth that so many could amass such enormous wealth in such diverse fashion as here in the United States . America’s unique environment made it possible. They have an obligation to share with the rest of this great country some of what they have earned. There is nothing wrong with the ability of Rockefellers, Fords, Mellons or Astors in successfully maintaining their wealth for generations. Indeed, they and many other dynasties have been able to do it successfully even with our current federal tax system. Taxation of very high incomes stresses that the very wealthy have social obligations. Even with the retention of a tax on very high incomes, most of the rich will pay lower taxes, often much lower taxes, under Sensible Tax Reform than they do under our current federal tax systems.
America needs to retain a fair-and-simple income tax on very high incomes primarily for fairness. However, it will also be needed for revenue and for social and political safety. There is no way that a sales tax only, one that exempts very high levels of income and wealth transfer from any income-taxation at all, will ever gain the support of moderates and liberals. Without their support, the consumption tax will never become law.
Back to TopWhat counts as taxable income under Sensible Tax Reform?
All income, from whatever source, will be counted as income, and treated the same. No form of income will be tax exempt or be taxed at preferential tax rates. Salaries and wages, commissions and tips, interest and dividends, capital gains and bonuses, alimony and inheritance will all be treated alike. All of the income, from whatever source, will also be equally subject to the $1 million annual income exclusion, as well as the unlimited charitable-donation deduction. All remaining net taxable income will be taxed at the same rates.
Back to TopUnder existing tax rules, dividends and capital gains are taxed at no more than half the tax rate that applies to other sources of income. Why will they not be given the same preferential treatment under Sensible Tax Reform?
Under the Internal Revenue Code, a very favorable maximum tax rate of only 15% has been bestowed upon dividends and capital gains. Such favoritism, which is in fact a form of tax subsidy, was introduced to minimize double taxation.
Dividends are paid after taxes have been paid by the company. Any dividends that are paid will generally be taxed a second time--by the recipient. It would have made great sense economically to make dividend payments tax deductible to the company and taxable to the recipient. However, Congress chose to give the deduction to the recipients of the dividends--but not all recipients. Only those who receive dividends outside of tax-sheltered investment accounts, such as IRAs and 401(k) retirement accounts, receive the preferential 15% tax rate. Under Sensible Tax Reform, since businesses will pay no taxes so that dividends will be paid pre-tax by the company. For the recipient, the dividends will be treated the same as all other sources of income and all dividend recipients will be treated alike.
Under current rules, capital gains are also given the same very preferential 15% tax rate as are dividends. That special treatment is based upon the somewhat dubious argument that there is also double taxation involved in capital gains. Even if the argument were valid, which is much less defensible than for dividends, there are other very favorable rules which already greatly reduce the incidence of normal tax rates on capital gains. First, capital gains are generally not paid annually but can usually be postponed to a time of the taxpayer’s choosing. If the gains are from the sale of a house, up to $500,000 of the capital gains are tax deductible. [And that benefit can be earned multiple times by the same family.] The benefits from such rules overwhelmingly benefit the wealthy who receive the vast bulk of capital gains. Under STR, all income, including capital gains, and all groups of taxpayers will be treated alike.
Back to TopHow is the withdrawal of savings treated under Sensible Tax Reform?
Savings which already exist at the time that STR goes into effect (i.e., savings which have been made under current tax rules) will be treated in an analogous fashion to what is currently done. Savings which are not tax-sheltered were made with after-tax income. The original investment will have already been taxed and will be tax exempt. Any income (whether dividends, interest or capital gains) from that investment will be included in annual taxable income in the year paid.
Under Sensible Tax Reform, there will be no need for tax-sheltered accounts, since $1 million of income will be completely excluded from income taxes every year. Savings which have been tax-sheltered under current tax laws have not yet been taxed. All income from those investments, including capital gains, along with the principal will be included as part of annual income when received.
Savings which are made after STR goes into effect will not generally have been taxed. As with pre- STR tax-sheltered income, any gains (e.g., interest, dividends or capital gains) will be included in the taxpayer’s taxable income for that year. Any invested principal that had been previously been included in annual income and subject to income-tax (even if it escaped taxation due to the $1 million tax exclusion and charity deduction) will not again be counted as income.
Therefore, the gain from the investment will be included as taxable income, but the original investment will not.
Back to TopHow would Sensible Tax Reform affect deductions for mortgage interest payments and property taxes?
Other than charitable donations, there will be no deductions from income under STR. One of the worst aspects of the current Internal Revenue Code is its complexity. Part of its complexity is the inclusion of deductions and credits, generally for either socially-motivated or politically-motivated reasons. No matter how laudable the motivation might be, it does not warrant being included in the tax code. Sensible Tax Reform will be simple, very simple. Except for charitable giving, there will be no deductions.
Back to TopHow would Sensible Tax Reform affect credits?
Like existing tax deductions, many credits have been imposed upon the current federal tax system. Like the deductions, some are laudable while many are very questionable. In any event, they do not belong in our tax system and will not be part of Sensible Tax Reform--Fair, Simple and Effective. Simplicity is very important. If the government wishes to subsidize some behavior (for example, energy conservation or home ownership), then it should be done openly, honestly and everyone should be treated alike in its application. It should not be hidden in the tax system, with most of the benefits going to the very wealthy as occurs today.
Back to TopWhat would our tax-compliance obligation be under Sensible Tax Reform?
98% of taxpayers would have no annual obligation at all. Only those with very high annual income (perhaps $700,000 or more) would even need to file. For the rest of us, there will be no need to fear the Internal Revenue Service. There will be no need to keep extensive financial records for three years or more. There will be no fears of IRS audits and penalties. 98% will be totally exempted from this annual ritual.
Back to TopWhat would the income-tax rates be under Sensible Tax Reform?
here will be only three income-tax rates. After the $1 million income exclusion and the deduction for charitable contributions, the remaining income will be taxable. The first $10 million of net taxable income will be taxed at 15%. [Under current federal tax law (for 2008), the 15% rate applies to a family at $16,050 of income.] Net taxable income between $10 million and $25 million will be taxed at 25%. [Under current federal tax law, the 25% rate kicks in at only $65,100 of income.] Annual net taxable income greater than $25 million will be taxed at a rate of 35% [whereas at present the 35% applies to income as low as $358,000].
For example, a corporate president with $5 million of income and $1 million of charitable donations would only pay taxes on $3 million of taxable income. 15% of that would be $450,000, which is an average tax rate of only 9% on $5 million of total income. Likewise a professional athlete or actor with $25 million of income and $5 million of donations would only pay taxes on $19 million. The average tax rate would only be 19.7%. Finally, someone with $200 million of dividends, interest and capital gains and $30 million of donations would pay an average tax rate of 27.8%.
