I know that it is not tax season right now. However, having to send in estimated tax payments this year - with one payment due in the past couple of weeks - I am regularly thinking about it. Seeing an article on CNN about Congress dragging their feet on AMT reform raised the interest level too.

Other information that I have heard recently also supports my thinking about changes that should be made to the federal income tax. Real estate gurus and even Rich Dad author Robert Kiyosaki helped drive home the point that taxes are inefficient and are not progressive like they are claimed to be. The rich have the ability to control how they make their money which allows them to keep more of it by despite a higher marginal tax rate.

Even those gurus and guides that we look up to will acknowledge that taxes are complex and take a lot of time and money to figure out properly and to plan for how best to reduce their tax liability. The government knows this as well, requiring that estimates of how long it takes to prepare an average return be included in the tax preparation materials.

All this, and a lot more, has driven me to the conclusion that the tax code needs to be made as simple as possible. All of the different deductions, credits, and differing tax rates on different types of income make filing taxes a more complex and difficult task than it should. It also has relatively little impact on most people's actions - they do not change their behavior to minimize their tax burden. So, all of the tax provisions aiming to promote certain behaviors are significantly less effective than their authors would like to believe.

Social Engineering

Then there is the question of if the government should be in the role of being social engineers - changing incentives and penalties to get desired behavior out of the populace that would not naturally occur. It is not just the tax code that is manipulated to do that either. Welfare, insurance and financial regulations and more extend beyond basic programs and the rules behind each of those are written in such a way as to reward certain actions - actions that are not always in the best interest of society or individuals.

Lets look at just a few examples from the tax code. First is the home mortgage interest deduction. This deduction is in place to encourage people to own a home by artificially making it less expensive to pay for it. Essentially, it subsidizes home owners who maintain a mortgage on their home. Thus, indirectly the federal government helps encourage urban sprawl which has its own list of benefits and downfalls.

Second are all of the per person credits and per child credits. Like the home mortgage interest deduction, these credits reward certain behavior. In this case, it is having a large family. So the federal government is in the business of encouraging procreation [while trying to discourage teenage pregnancy]. Yes, these credits and deductions do not fully offset the additional costs of raising a child. They do however offset those costs which helps to promote that act.

Third is the preferential treatment of capital gains. By choosing to tax capital gains at a lower rate, the official line is that it is to encourage people to invest in American companies, thus driving economic growth, creating more jobs and helping us live better than we would otherwise. What it actually does for a government that is deficit spending is tax our labor at a higher rate.

Spending

Now, before I get into my thoughts on what would be a reasonable tax plan, there is another side to this equation that matters more in some ways than taxes. It is government spending. Regardless of how fair or unfair, simple of complex a tax system is, the spending on the other side actually has more of an economic impact. Without restraint in spending, it does not matter how much is collected in taxes. Now, I will not expound on spending right now beyond saying that I think the federal government needs to do less while state governments need to do more and the American citizens ought to take on more responsibility for their own communities rather than handing it off to government at all levels.

Required Tax Complexity

Now, I do realize that no matter what I propose, there is a certain level of complexity that has to be involved. Things need to be defined and guidelines need to be set - especially on the corporate side - on how to determine certain values that are used to determine tax liability. It may be possible to get to where some people's taxes could be filed via postcard, but that vision is more dream than reasonable.

Complexity would come from how to treat certain plans that are in place now like 401k, 529, IRA and similar that give favorable tax treatments for saving for the future. Municipal bonds and more would also be significantly impacted. This treatment would be part of an appropriately crafted rework of the current federal revenue program as enacted by the US Congress.

Reasonable Tax Plan

My proposal is that all income be taxed equally regardless of source. Income taxes should be progressive with the rich paying much more for each marginal dollar than somebody at the poverty line. Rather than have different classifications of taxpayer (single, married filing jointly, etc.), there should be a single tax chart for individuals and a single chart for corporations. Each person who makes money in a given year would file separately. There should be no deductions or credits for any particular activity.

Explanation

Income taxes are enacted so that the government can have the funds necessary to carry out its duty. Ideally, the government would only take the funds it needs and would not take so much that it leaves even low wage workers destitute. In my opinion, this requirement to collect revenue needs to be divorced from the process of spending completely. By simplifying the tax collection process, it becomes more of a revenue tool and less of a policy tool.

As an example, with no child-care tax credit, the government will have to make the decision if it wants to take its hard earned revenue and actually pay for child care. That means that we get to choose, through the representatives we elect, if we want the government to be more Socialist by subsidizing child care and more, or if we want to be more Capitalist and market driven.

For those who are concerned that eliminating credits and deductions will harm the poor more than the rich, consider the power of setting the marginal tax rates. By setting a rate of 0% on earnings up to a certain amount (say $15,000), the poorest workers will not be subjected to any taxes. Offsetting that, choosing a 35%, 40% or even 50% tax rate for all income above a certain level (say $500,000) we wind up with a progressive tax system that will not works to avoid pushing people to poverty while still collecting enough revenue for the government to function.

Lastly is the proposal to have every taxpayer file separately. This will eliminate the marriage tax penalty (which still exists) while collecting from each person according to the same standards. A high-earning wife will not force her husband to pay higher taxes on his income than he would on his own. A day-trader will pay on his earning the same as a business owner, construction worker, real estate investor or librarian. It would be easy to predict the impact of individual decisions on your annual tax liability because there are fewer, simpler rules to know and understand.

Follow up

I like this plan for a lot of reasons. First, it frees up a lot of time for people to use more productively with their families, friends, or developing their businesses and careers. As a part of that, all the economic activity spent on calculating taxes is freed up for use keeping America competitive in the world economy. Second, it does not require a college degree to figure out how much money somebody is paying for the government. Third, it will force the government to find new ways to hide their social engineering efforts. Finally, it treats everybody equally regardless of how they make their money.

Yes, adopting this plan would change a lot of things for people financially. The transition would have to be approached with a lot of care and caution otherwise chaos and harm could be done to a lot of people. Still, properly planned, this change could offer a lot of people benefits in how they handle their day to day financial lives and long term planning.

Please leave your comments about this idea. Once there are enough suggestions, criticisms and alternatives, I will summarize and respond with a follow-up post. I would love to see ideas that help lead to fleshing this out with the details necessary for it to become a useful tool in debates about federal taxes.

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