A simpler way to pay taxes

April 15, 2009

 Diana Furchtgott-Roth– Diana Furchtgott-Roth, dfr@hudson.org, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute. The views expressed are her own.  –

It’s April 15, and you’ve finished the arduous task of filing your taxes. You’ve found your W-2 form from your employer, your pennies of interest income from your checking account. If you itemize, you’ve tracked down the acknowledgement of your charitable contributions to the church, the Sierra Club, and the local anti-poverty organization.

The system is so complex that it may have contributed to the tax delinquencies of four Cabinet-level Obama appointees (or their spouses) who had to pay up to win Senate confirmation. At least two other Obama choices withdrew because of their tax problems.

President Obama recognizes the problem. Today he asked his Economic Advisory Board, under the leadership of former Federal Reserve Chairman Paul Volcker, to send him recommendations for tax simplification by the end of the year.

Enter Wisconsin Representative Paul Ryan, a member of Congress for 10 years and now the ranking Republican on the House Budget Committee. In H.R. 6110, entitled “Roadmap for America’s Future” (www.americanroadmap.org), he has proposed a radical simplification of the tax code.

Mr. Ryan describes the tax system as “needlessly complex and burdensome.” In contrast, he writes, “a world-class tax system should be simple, fair, and efficient. The U.S. tax code fails on all three counts.”
Under the Ryan proposal, couples would pay tax at a 10 percent rate on their first $100,000 of taxable income ($50,000 for singles), and then 25 percent on any earnings above that. They would pay a 15 percent tax on capital gains and dividends, and no tax on savings. In exchange, they would give up almost all deductions, including home mortgage interest and charitable contributions.

The only deduction allowed would be a refundable $5,000 tax credit for families and $2,500 for individuals to help with the purchase of private-sector health insurance. Health insurance could be purchased in any state, to encourage more companies and plans to participate.

Many efforts to simplify the tax code have failed because people are attached to their deductions — and because Congress seeks to use tax law to achieve social goals, such as home ownership and helping low-income parents with the earned-income tax credit, a stunningly complex provision.

Moreover, charities and universities fear, probably with good reason, that if contributions are not deductible, people will give less.

To disarm the opposition, Mr. Ryan would give taxpayers a choice. Within 10 years of the passage of the law, they could choose today’s system, with its multiple rates and deductions; or they could adopt the simplified Ryan system, giving up the deductions. To prevent people from switching every year if it would benefit them, they could change only once in a lifetime — except in the case of what Ryan calls “a life-changing event,” such as death, divorce, or marriage, when an additional change would be permitted.

Mr. Ryan’s proposal is a variant of the flat, or one-rate, tax suggested in the Reagan era by some economists and advocated in the 1980s by then House Majority Leader Dick Armey, and later by Steve Forbes in his 1996 and 2000 bids for the Republican presidential nomination.

Then, the main attack on the idea was that it is inequitable. However, Mr. Ryan’s tax contains not one but two rates, and it is progressive because it retains standard deductions and personal exemptions. A family of four would start paying tax only after earning $39,000. Further, many upper-income people benefit from existing deductions, and they would lose this benefit if they adopt Ryan’s two-rate tariff.

No tax proposal offered by a minority member of Congress of either party ever has any chance of passage. Political loyalties aside, the American public might want to take a careful look at Mr. Ryan’s proposal, while memories of filling out their tax forms are still fresh.

31 comments

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B.Free,
With all due respect, no sales tax would collect anything from off-the-books cash only transactions. Can you imagine a street drug dealer collecting extra money on behalf of IRS (OK, collection may be plausible :-) ) and actually submitting the collected amount to IRS as official crack cocaine sales tax?
Tax exemption cards for unemployed/poor will only help to game the system in more ways. How about this scenario: the poor would accompany the rich to a supermarket, and then split the tax savings?
One more thing that may happen – shifting of business from brick and mortar stores to Internet. This way at least the state portion of sales tax would be eliminated. Both states and malls will suffer.
Multiple scale taxation (food/medicine/basic goods/”regular” goods/luxury items) leaves too much for the IRS/Congress to decide. For instance, is caviar food or luxury? An apartment/house is rented for $1500/month – is it a luxury mansion (could be in TX) or a basic housing (NYC)? Breast implant – is it a luxury item, or a necessity (think of breast cancer victim disfigured by mastectomy)? And again complications in accounting.
The only way to tax black, gray, and whatever other color market is to eliminate cash and make the economy electronic transaction only. Will also eliminate illegal immigration (no legal status, no money card), robberies, drug dealing, and whatever other crimes committed to obtain cash or by means of cash operations. Technically it’s already possible. But doesn’t it smell much like Big Brother?

Posted by anonymous | Report as abusive

The sales tax wouldn’t collect anything directly from a drug or off the book transaction, but that money will eventually be spent on something legal, where it will be taxed. With the income tax system, it never gets taxed.

Posted by drewbie | Report as abusive

Anonymous that is not what I meant. Of course black market sales will not be taxed but, the profits from those sales will be spent and taxed at that time under a national sales tax. What I am trying to say is that the income from black markets is not taxed now but, under a national sales tax, it would be taxed as that income is spent.

No, black market sales cannot be taxed. This is why our nation should make every effort to ensure there are few and small black markets.

If you don’t like the card you can go with Ron Paul and have the lower income population file for the return of the sales tax. I like the card idea myself but am open to ideas. I like the card because the only way it can be gamed is through counterfeiting. Today we have the technology to track whose card is being used and how much it is being used. Every credit card and even your grocery store use this technology to track what you buy and how much you buy.

I have to admit I am confused about your multiple scale taxation statement. The federal government today has established qualified purchases with their credit cards. For example, if I work for the government and travel, I cannot use a federal credit card to buy a stereo or furniture because this type of purchase falls outside of the type a federal traveler would incur. This would be no different I am sure there would be some credit card company who would be eager to get this federal contract.

As for Big Brother, that is something a National Sales Tax would help to prevent. It is one thing if I am asking for federal assistance. If I am on the dole, than the government has a valid reason to be in my business. If not, then what business is it of theirs what I make or spend or save? A national sales tax would put some distance between you and the government.

Posted by B.Free | Report as abusive

B.Free,
“I am confused about your multiple scale taxation statement.”
But this is what you wrote in your previous post: “In fact they should be exempt from all taxation on basic goods and services, not luxury sales.” 0% tax for “basic goods and services” vs. X% tax for “luxury sales”. That’s an example of 2 tier taxation, isn’t it? And it will not take long to make 2-tier system into n-tier – something along the lines of basic/regular/luxury/ultra-luxury.
Worse yet, if it’s determined in Washington what goods/services belong to what tier, there will be a lot of confusion and complication, especially if the states also move from income to sales tax. Add to that “green” discounts” and “carbon surcharges” that were suggested in other discussions – and the simple sales tax system mutates into a monster.
Now try to follow this: This item is taxed federally as “luxury”, but by the state as “regular”, and tax exempt to exemption card bearers, but only on federal portion, with manufacturer’s coupons applied to aftertax amount – did I succeed to make you confused? If you let the bureaucrats decide what goods and services taxed at what rates and to whom, they’ll manage to make it even more confusing. And that’s what we should expect when we move to sales tax from current income tax system. As soon as it happens, the “social justice” proponents will yell and scream that it’s not fair to tax bread the same as diamonds, and Hyundai compact the same as Rolls Royce – and the Congress will listen.

Posted by Anonymous | Report as abusive

except that there aren’t any such divides for a state sales tax. An item is either taxable, or not. Why would it be different on a national scale? Your example of Hyundai compact vs Rolls Royce doesn’t make much sense, because the buyer of a Rolls is going to pay more in tax than the Hyundai owner.

Posted by Drewbie | Report as abusive

Taxation has to be turned upside down. Capital gains taxes should be entirely abolished. For instance, a level of government should only collect tax for something once. Currently if I buy a car, I pay tax. The person buying the car from me should not pay tax. The government did not contribute anything new. Why in the world are they trying to get more cash. Why do they expect more. When tax rates go up although nothing has changed, that should be illegal. It should be a criminal offence. In fact we should find out who came up with the idea originally and jail all of their offspring until they pay us all back. Plus people who go to jail should be forced to work at minimum wage to pay for the guards and facilities.

I’m not even sure why we are bothering with tax. We keep talking about stimulating the economy. Just don’t collect tax. What is all of this shuffling around taking money and then sending people a check. I know it is just to keep bureaucrats, pencil pushers, clerks and bean counters employed. Do we have time for that sort of rubbish anymore.

Posted by Don | Report as abusive

Anonymous, this is not a new idea. The use of a preloaded card is currently being reviewed in many states. The cards would replace food stamps. It would provide better control with better feed back on who is buying what with purchase restrictions built into the card. This card would be similar to the Federal Travel Credit Card program which restricts purchases to travel essential purchases. All I suggest is that under Federal Sales Tax individuals on unemployment and welfare would be exempt from the tax and the card would be an easy way to implement this. This is really just a side issue to the current topic.

The Issue is that an income tax is neither fair, effective or cost efficient. Even the two tier rate system suggested in this article fails to consider the real issues with an income tax. A national sales tax would be cost efficient to both the individual and the government by reducing the cost and time needed to execute the program. It is effective because it directly ties tax revenue to GNP and brings a large part of our society who is currently not paying taxes into the fold automatically. It is fair because those who earn more disposable income spend more than those that don’t hence they pay more taxes and while smoothing out the cost of living variances it encourages investment and saving.

Posted by B.Free | Report as abusive

Let’s say I am a mob kingpin. I lend Dick $100,000. But on paper I buy a $100,000 worth of motors from him. These motors are defective. So I will write them off. Dick pays me back $150,000. But on paper he buys a $10,000 piece of property from me for $150,000. I make $140,000 on the property but lose $100,000 on the motors. So I gain $40,000 legally as a mob kingpin on the deal. But do you really think I can’t find $40,000 worth of fluff to put against the gains. With all of this capital being slung around, of course I can find $40,000 worth of fluff. It is too easy to hide capital gains. There is no point taxing it. We just create an industry of backoffice doctors and magicians.

Now if we apply a flat tax on an employee, her ability to pay increases the greater her income. Her ability to buy stuff is likewise preserved if the tax rate is flat, so she has no disincentive to spend a lot. The cost of a new computer is much greater for a person in a high tax bracket than a low-income person. Plus the government is actually earning its pay. It should get a cut of what I get. Even an unemployed person has to spend. The government should get a cut just because I have to buy stuff to survive.

Posted by Don | Report as abusive

This is a nice idea, possibly slightly better than the current system, but it is still an income tax and therefore nothing to get excited about. This proposal does nothing to quell the rampant exploitation of our tax code by the political majority of the day to punish and reward whichever demographic best complements their particular agenda. In addition, it does not address the most insidious bait-and-switch scam in history – payroll deductions. Maybe some reform is better than none; just don’t expect anyone to get excited about this one.

Posted by Matthew L. | Report as abusive

The current Tax Code acknowledges social and economic differences in the population at large. Many with low income do not pay anything like 10% in Federal Taxes and therefore would be penalised with a flat tax.

Posted by Wilson | Report as abusive

An excellent proposal! One suggestion though, there should be no taxes on any earned income up to the poverty level. This will accommodate the people who spend all their earnings on food and other necessities, and will overcome the criticism of being regressive.

Posted by mool shekhawat | Report as abusive