WASHINGTON, March 6, 2015 — Almost everyone agrees that the current multi-million word tax code must be replaced. One alternative is the “fair tax” on consumption. Another is Sen. Mike Lee’s plan to reduce the number of tax brackets to two, 15 and 35 percent while eliminating taxes on capital gains and dividends. Lee’s plan also eliminates almost all deductions except for charitable donations and mortgage interest expense.
Does either plan make sense?
The consumption tax is a national sales tax. The logic is that people should be taxed on what they take out of the system rather than what they are paid. This plan virtually eliminates the IRS.
While consumption taxes are regressive, the proponents of this plan propose varying sales tax rates based on products purchased, with pre-bates given to offset any tax burden on low-income consumers. The problem is that any tax on consumption will always place a higher relative tax burden on the lowest income earners: Low income earners spend all of their income, meaning they pay tax on all income.
While complicated schemes may help reduce the burden, this is clearly a tax cut for the wealthy. The wealthy spend smaller portions of their income; someone with a $1 million income may spend only a few hundred thousand and save or invest the rest. The very successful individual with $10 million income may spend only $1 or $2 million; the remainder will not be taxed. The very wealthy could see their tax rate as a percent of income—which is usually how tax burden is measured—fall dramatically.
Any tax on consumption is regressive, no matter what schemes may accompany it.
Utah Republican Lee has a different idea. His plan reduces the tax brackets to 15 percent and 35 percent for individuals, while retaining deductions for politically sensitive items like charitable deductions and home mortgage interest expense. This is popular in the housing industry, but it distorts the market and causes long-term problems. Remember the mortgage crisis that led to the financial meltdown and to the severe recession?
Lee would also eliminate taxes on capital gains, meaning he would tax capital at a lower rate than labor. Many argue that’s not fair. His plan would also add significantly to the deficit, probably increasing it by about $240 billion per year for the next 10 years. But it should add significantly to economic growth, which is really the solution to our long-term problems, including public debt.
There is a much better alternative. The single rate tax plan is really the best for the majority of people. The plan says that all income above a livable minimum will be taxed at a 15 percent rate, no matter how much income is earned or how the income is spent.
There would be no deductions for anything. In addition, business would be taxed on cash flow rather than income, so that capital purchases are completely expensed each year.
Capital gains and dividend income would also be taxed at 15 percent. The livable minimum would be set at two times the poverty rate. Corporations would also be taxed at 15 percent.
This plan treats all taxpayers exactly the same. It does not favor home-owners over renters, avoiding market distortions. It raises an additional $200 billion per year in tax revenue, adds significantly to economic growth, taxes labor and capital at the same rate, eliminates all loopholes, virtually eliminates the IRS, brings corporate funds earned outside of the United States back here, and may even encourage foreign companies to locate here. It removes the divisive nature of the current code, since everyone is treated exactly the same.
In addition, the tax filing at year’s end is simple. An individual simply adds up all of his or her income from wages and salaries, rent, interest, profits, capital gains and dividends, then subtracts the livable minimum. The balance is multiplied by .15, and that’s the tax that is due.
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