Liberals hold to the idea that everyone should pay their “fair share” of taxes. Hell, I’d be happy if we could get the ultra-wealthy to pay some taxes. The bottom line is that we need a system of taxation that really works. Clearly, the plan we have in America does not work. Not even on paper. Let’s fix it.
Originally published 2013
We need a tax plan that really works. Clearly, our current plan in the United States does not. It doesn’t even work on paper, because no one thinks that a 90% tax rate is fair — even people who will never have that rate in sight — because that kind of tax rate ruins even the dream of financial success. So we’ll start by fixing that. But first, let’s establish the goals of the plan.
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Goals of the Plan
The goal is to set the stage for prosperity — for everyone. The income it generates builds smooth roads, free education, health care, and unlimited high speed internet for everyone. So it paves the way both for a healthy, fulfilled society, and for successful entreprenurial endeavors. The rates are set in a manner that everyone feels they are contributing to it, and no one feels that advantage has been taken.
Reasonable Tax Rates
At it’s best, the “American Dream” is equivalent to a lottery ticket. In the lottery, a $1 ticket buys you a million dollars’ worth of dreams, as friend Mark Blake once told me. The simple fact of living in America should buy you that dream, as well. It did, once. It should do so again.
So let’s start by setting the maximum tax rate at say, 50%. Or maybe 45% is the ideal number. Or maybe it’s 55%. Let’s get some psychologists involved. At what point does the rate become so high that it turns people off? What is the highest point at which people take pride in how much they pay — and boast about it, rather than in how little they pay?
Because the fact is that personal and corporate success is made possible by societal infrastructure. Housing and commuting systems make it possible to have workers. Transportation systems allow for the sharing of raw materials, supplies, and machinery. Communications systems allow for the coordination and sharing of services.
In short, social infrastructure sets the stage for prosperity, and a reasonable tax rate allows for the creation and maintenance of that infrastructure. So decent tax revenues set the stage for prosperity for everyone.
At the same time, a minimum tax rate is required. For example: 1%. One percent. That really isn’t a lot. But everyone who works for their living can take pride in the fact that they paid their share, to contribute to the infrastructure that makes success possible.
Top Tax Bracket Equivalent to the “Windfall” Tax Rate
If you win the lottery or a TV game show, there is a limit to what Uncle Sam will take. The idea is that you’re unlikely to repeat the event, so a 90% bracket would be ridiculous. I’m not sure what that rate is. Maybe it’s 40%. Whatever it is, the top tax bracket should be the same.
In effect then, a fantastic income is simply a “windfall” that happens every year. Whatever is fair for one is fair for the other. Boom. One less item in the tax code. Because everyone is taxed at the same rate, all the time.
Inflation-Adjusted Tax Brackets
We know we want tax rates that range from, say, 1% to 50%. In today’s dollars, lets say that if you made less than $10,000, your tax rate is 1%. So if you made $9,999 you owe $99.99 in taxes. That’s $100. If you made $10,000. Seems reasonable. But maybe it’s a lot, for a person living on such an income. So maybe that’s the corporate tax rate. And maybe the personal tax rate is a tenth of that. You made $10,000? Fine. You owe $10 in taxes. That kind of tax rate doesn’t hurt anyone.
At the other end, maybe the top tax bracket comes into play at $20m. You made $20m, you owe $10m in taxes at a 50% rate, or less at a 40% rate. Have a problem with that? Boo hoo. I’m crying inside, where the tears don’t show. I’m pretty sure you can get by on $10m. Give it to me. I’ll show you.
But the real issue is avoiding “inflation creep” that moves people into higher and higher tax brackets, even though their effective income is the same. Similarly, if there is deflation, people are moved into lower tax brackets, even though their effective income is higher.
This is an area where economists could get into the picture. Perhaps the existence of fixed tax brackets would help to stabilize the economy, and work to prevent either inflation or deflation? If so, then the brackets don’t need to change. But if the forces that cause either one are independent of the tax structure (or are much stronger than the impetus towards a status quo that it provides), then the brackets need to be adjusted — once every 10 years, at a minimum, or whenever a “sudden change” occurs in the economy.
Or perhaps a decent amount of inflation is a good thing, because it gives people a sense of achievement. They feel like they are making more. And they are, for a while, until rising costs eventually force higher prices. But if the sense of satisfaction makes a happier populace, there is something to be said for it.
But if inflation is desirable, then it is also necessary to periodically adjust the tax brackets. Otherwise, in a couple of hundred years, someone making the equivalent of $10,000 today could well be paying the same 50% in tax that someone with a multi-trillion dollar income is paying.
Gradually Adjusting Brackets
So the tax brackets start at, say, .01% for personal income, and 10% for corporate income at $10k, and they go up to something like 40 or 50% at $20m. If the top rate is 50%, then divide that range into 51 brackets (one for .01%, and one each for 1 to 50%), and bump up the tax rate by 1% in each bracket.
That sort of gradual increase in your tax bracket doesn’t hurt that much. So you don’t wind up going to the ends of the earth to keep from jumping from 20% to 35%, for example — especially if your ability to keep making that kind of money is uncertain — as are all business endeavors.
When people were doing everything by hand — and all of the filed returns were checked by hand — it was necessary to have a few fixed ranges, and to have fixed brackets that stayed the same from year to year.
But these days, returns are prepared and checked by computers. And the brackets themselves can be made available online, where they can be easily accessed. So a plethora of brackets and changes to their ranges are easily accomoated, in today’s world.
So the bracket ranges could easily change from year to year. Doing so would allow for small, incremental adjustements.
On the other hand, revising them at 10-year intervals provides a fixed “planning horizon”, that is beneficial. However, the cost of doing it is the need to allow for “sudden changes” to the economy, like a short term financial collapse, and the prospect that as the 10-year anniversary comes closer, a larger adjustment will be made, which disrupts any plan that extends beyond the anniversary. Either of those situtations makes planning more difficult, so it probably makes more sense to have annual, incremental adjustments.
I suspect that the solution, ultimately, is to publish the planned rates as far in advance as possible, for the long-term planners. That way, the financial community can take the planned adjustments into account as they are published, the same way they take into account other economic indicators published by the government.
Donation-Adjusted Taxes
The whole idea of government is to take care of its citizenry — and to employ the kind of foresight for that purpose that only the best and brightest posess. I think of ancient Egypt, where a 10% tax on grain was instituted, in order to prepare for the Nile floods that reoccured at 7-year intervals. The best and brightest saved for that day. Others starved. Government applied the policies of the best and brightest to all, so they incurred a little hurt each year, but reaped major benefits when it counted.
It certainly makes sense, then, to reduce the tax rate by the degree to which donations are made to independent organizations who are also fulfilling that purpose. After all, if the money is benefiting society, it need not do so by going to the government first. We already have mechanism in place to determine which organizations qualify for such treatment. So we don’t need to create anything new. We can use what we have.
On the other hand, there also needs to be a limit on that kind of giving. All the well-intended organizations in the world will not provide smooth roads everywhere — and jobs for the people who pave them. So there is a limit to how much can be offset by giving to other organizations.
Let’s put a stake in the ground, and say that the limit is 25% of the taxes you would otherwise owe. This is an amount that needs to be discussed, and decided. Maybe the optimal amount is 30%. Or 50%. Or maybe it is 20%. I suspect that government should start with a lower value, and then peridocically adjust. Have a growing surplus? Raise the donation-limit, to encourage the formation of beneficial tax-free non-profits. Have a dwindling surplus, lower the limit until balance is restored.
Note:
I started out thinking that donations would be an adjustment to income. But then I realized that if the top tax bracket is at $20m, then anyone making a lot more than that would have little incentive to do any charitable giving. They could never reduce their income enough to have an impact. So it makes more sense to adjust the amount of taxes owed, instead.
Zero “Loopholes”
In theory, this is a great idea — because a loophole, by definition, is something that lets someone else escape taxes they should have paid. We already have donation-adjustments to income, and my first inclination is to think that it should be enough. But it is entirely possible that some other way to adjust a person’s tax bracket will be helpful to society. So I don’t want to rule out the idea altogether.
At the same time, we cannot abide the current situation, in which there are so many volumes of tax law that no one understands them all, so whoever has the best lawyers gets to game the system as much as they want. So let’s limit the tax code to something like 100 pages, in 12-point font. That’s large enough to allow for a lot of tax relief, but small enough that a single shop owner could digest it in a month or two, and know the rules of the game.
Want to add something else? Fine. Find something to remove first. Take a vote on it, and get everyone to agree that soldiers don’t need a Civil-War era tax break on the cost of their shoes, now that Uncle Sam is providing them. Take that out, and put in the new thing that makes sense. Then highlight the changes and make the new version available, so everyone can digest the changes.
A Comprehensible Tax Code
To allow for any kind of personalized tax adjusments, some kind of tax code will be needed. We already know that we need to limit its size. This is another area where psychologists could get involved. How big can a tax code get and still be “digestable”?
But clarity is equally important. This another issue where psychologists and “usability testers” can have an impact: At what point do reasonably intelligent people start scratching their heads and asking, “What does this section mean?”. If a person of average intellect (something psychologists can define) does not understand it, then that section needs to be revised until a new test group finds it digestible.
That kind of “usability testing” must be required, before any new version of the tax code can be published.
Effective Estate Taxes
One thing that kept the American Dream alive for so long was the establishment of estate taxes. Those taxes prevented an “aristocracy of wealth” from forming, based on inherited wealth. In the 1990’s, that tax was abolished, “temporarily”. At the moment, I can’t say if it is back, or if the efforts to prevent its return were successful. But I can say with certainty that without it, the American Dream is dead. If not now, then tomorrow. If not immediately, then eventually.
So an estate tax of some kind is necessary, to “level the playing field”, in some manner. And again, I think that a negligible minimum rate for some reasonably-sized estate is fair and right.
But here, I think the maximum tax rate needs to go higher than the “windfall” rate. Maybe as high as 75%. Possibly 80%. (Psychologists, again.) But again, the brackets are the determinining factor. If that rate kicks in at a point where you are still leaving your family a few hundred million, I suspect that most families would be able to get by on that.
If all of your children get to go to the best colleges, launch businesses, and engage in the pursuits they enjoy, that is more than enough. That only leaves the surviving spouse. It seems reasonable that they should be able to continue to enjoy the lifestyle they became accustomed to. But complications arise from alimony and child support to previous partners, and when the surviving spouse takes a new partner.
Those are thorny problems that need a solution.
One alternative was suggested by Keith Shepperson: Inheritance is a form of income. An inheritance forms part of a person’s income, and is taxed the same as any other income. That proposal has the advantage that it is fairly simple — although there is still the small matter of valuation for property and other non-liquid assets. (The same problem arises for game show prizes.)
The proposal doesn’t quite prevent the formation of a billionaire class, but it does make things harder. If the money transitions enough times, and 50% is taken each time, it gets cut down pretty quickly. But if it transitions slowly enough, the aristocracy still forms, given enough time.
It’s a tough problem to solve. On the other hand, you want to give everyone a good bite of the apple, so everyone has an equal chance of success. On the other hand, you want to preserve a person’s legacy, and their ability to pass on their success to their children and surviving spouse. As in all things, balance is the key.
Until a better proposal surfaces, I’m inclined to think that treating inheritance as a form of income is a reasonable alternative.
Corporate Taxes
As I wrote in America’s REAL Corporate Tax Rate, America pays the lowest corporate income taxes among all industrialized nations. One reason the billionaire class gets away with it is that, on paper, we have the highest tax rate. So whenever anyone talks about change, the demagogues scream about how we already have the highest tax rate. But we have so many loopholes, and so many brilliant lawyers working them as a full time job, that the actual rate of payment is the lowest.
That situation has to stop. The loopholes that allow a company to sell their secret recipe to a “corporation” formed in a tax haven for $10, and then lease that recipe back for $10m a year have to be closed. Tell the company they’re free to send the $10m offshore, but they still owe taxes on that amount — minus the $10.00 that the recipe is worth (because that’s what they sold it for).
In general, then, use the principles described in this essay to set up a “fair share” system of taxes for corporations, as well as individuals.
Summary
Done right, everyone wins. Society gets a healthy, reasonably happy populace. Corporations get an infrastructure and a workforce that makes success possible. The taxes hurt, but not so much that are an actual disincentive to progress — or worse, that they form an active incentive to change the system in a way that benefits the few, the proud, the rich — instead of benefiting everyone.
I have no doubt that the plan I propose will need to be adjusted and revised, to achieve maximum success. But equally, I have no doubt that principles on which it is based must be maintained, to have any real and lasting success at all.
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