Tax reform is very much in the air these days. Proposals to fund President Biden’s ambitious infrastructure plan and related reconciliation bill for “soft” projects include the adoption of a first-time wealth tax on billionaires, elimination of the step-up in basis upon death, and a proposed minimum corporate tax levy.
I believe there is a far simpler and more equitable personal income tax alternative. In short, all individuals would pay the higher of 30% of their Adjusted Gross Income but no less than 20% of their Gross Income (with no tax due below a Gross Income of $50,000 and rates graduating from 10% at $50,000 to 20% at $200,000 and above). There would be no differentiating between Ordinary Income and Capital Gains rates and absolutely no deductions allowed against Gross Income. The 30% levy against Adjusted Gross Income would only apply to individuals with Gross Incomes greater than $500,000. The Alternative Minimum Tax would be eliminated.
Since Congress cannot be expected to resist the urge to fiddle with tax policy to benefit its chosen lobbies such as real estate and energy, and since I believe it is important to encourage charitable giving, tax planners (of whom I would hope there would be fewer) would be free to ply their skills in reducing their clients Adjusted Gross Income with all flavors of deductions and credits, but ultimately subject to the rule that no one pays an amount of tax less than their applicable percentage of Gross Income.
Since I claim this proposed tax policy is simple and fair a couple of examples might be helpful. Imagine Mary, a successful lawyer who makes $2,000,000 per year, has itemized deductions of $100,000 and donates $400,000 to charity. Mary’s Gross Income is $2,000,000 and her Adjusted Gross Income is $1,500,000. She would owe $400,000 in income tax at the top 20% rate applicable to Gross Income, but $450,000 at 30% of Adjusted Gross Income (since she exceeds the $500,000 Gross Income threshold). Mary would pay the higher amount unless she could be encouraged to contribute another $166,667 to her favorite charity, thereby reducing her Adjusted Gross Income to $1,333,333, and her tax payable to $400,000 under either prong of my proposed tax system.
Now lets imagine Robert, a successful teacher with a Gross Income of $80,000 per year and $2000 in charitable deductions. At a graduated tax rate of 12% (the rate applicable to Robert based on where his Gross Income lies from the $50,000 minimum to the $200,000 maximum rate), his income tax payable would be $9,600. The 30% tax on Adjusted Gross Income would not apply.
In practice even my simplified tax proposal would need some bells and whistles. So, for example, I have only described rates and thresholds applicable to individuals, and some adjustments would need to be made to cover couples filing jointly and family-size credits; however, these are well established tax concepts and would not overly complicate the system. Nor would this personal income tax proposal need to be adopted in isolation. Reforms to the estate tax regime and efforts to establish a minimum corporate tax could also be adopted.
Ever since I studied US Federal Tax in law school I have been shocked by the complexity, volume and questionable policy choices of the Tax Code. While my proposed system is far from perfect and I would welcome comments on how it could be improved, it is progressive, more fair, far simpler to administer, and should enable the average taxpayer to actually prepare his or her own taxes — an ordeal for which even the best law school education and many years practice at a top law firm could not prepare me.