This document outlines what I consider to be a simple, fair system of federal taxation which broadens the base of those who pay taxes, reduces tax rates for most individuals and businesses, eliminates unfair tax advantages, and provides a predictable income stream for operation of the enumerated and implied powers of the federal government.
- Everyone with a category of “income” that will be specified by law pays at least some federal tax to support the “common defense and general welfare” (e.g., transportation systems) of our nation. This also ensures that all citizens of voting age who earn an “income” have a stake in federal budget allocations. No adult can be said to be “free-loading” by receiving benefits derived solely from someone else’s earnings.
- The lowest tax rate would apply from $1 earned up to $25,000, with the tax percentage increasing by 1% for every $5,000 thereafter, with a maximum rate of 15%.
- S. citizens, permanent residents, work visa holders, U.S.-owned businesses operating in the U.S., and foreign businesses operating in the U.S. will all be subject to the same graduated income tax scale. No one gets special treatment – the tax is fairly applied to all who have income of some sort. The graduated tax ensures that those who earn less pay a lesser proportion of their total income.
- The income tax system is greatly simplified by establishing clear income delineations for each tax level, and eliminating all exemptions, deductions, credits, etc.
- Non-profit entities remain exempt from paying income tax on charitable donations they receive. However, there is no taxpayer deduction for charitable contributions.
- Retirement payments that were deposited by the employee as part of taxable income (e.g., Social Security, Roth IRAs) or deposited by the employer as a benefit of employment (e.g., employer matching Social Security, FERS or CSRS) are not taxable. Retirement plan payments that were deducted or invested without paying taxes (e.g., IRAS, 401k’s) are taxable when the assets are withdrawn. All prior plans that were established with tax-exempt provisions (e.g., IRAs, Roth IRAs, 401k’s, ESAs) will continue to earn tax-exempt interest.
- Businesses’ tax rates are calculated based on net profit, after calculation of business operating expenses, etc. Some form of profit-loss worksheet will still be needed for businesses. However, “loopholes” and credits, exemptions, etc. that are currently applied non-uniformly must be eliminated.
- The proposed tax should be implemented on a trial basis for perhaps 5 years, with opportunity for renewal, modification, or “sunset” (expiration) at that time.
- Taxes on wages and salaries will continue to be collected when the wages are earned, based on an estimated percent of total annual income (see far right column in the chart below). This will ensure a steady stream of revenue for federal government operations.
- Inheritance is specifically excluded as “income.” Those monies were already taxed in the year when they were accumulated by the deceased, whether those assets were earnings, interest, dividends, or capital gains. Inheritance of real property is likewise tax exempt. Tax-deferred assets such as IRAs and ESAs are taxable when the assets are withdrawn, in compliance with existing law.
Benefits of the Proposed Tax Plan:
- Federal revenue will be simpler to project, because all exemptions, deductions, loopholes, etc. will be eliminated.
- Businesses and individuals will be able to determine with better accuracy how much tax will be paid annually. They will also, therefore, be able to project assets available for savings, capital improvement, and investment.
- The tax rate for low and middle income wage earners is very low, and most, if not all, Americans will experience a decline in their tax rate.
- Citizens will have more money for discretionary spending to meet their personal, family, and business needs, reduce reliance on federal and state government programs, and invest/save for future needs.
- The income ranges can be adjusted to reduce the tax burden on lower income persons and businesses, if voted on by Congress. However, all persons should be paying at least 1%!
- Requiring low and middle income earners to pay a low percentage tax will increase the likelihood those citizens will pay attention to decisions related to federal government spending, and will reject those budget items that are outside the enumerated or implied powers of the federal government.
- The rate of participation in federal taxation will increase, broadening the base of revenue collection.
- Lobbyists and other groups that seek to influence political decisions will have reduced power because there will be no “loophole” tax items they can seek to influence.
- Charitable donations to non-profit groups will be based on true charity and support of the organization’s work, rather than anticipation of a tax deduction.
- Individuals and businesses will be able to calculate their own taxes, rather than hiring accountants.
- If more revenues are needed, such as in time of war, (a) the tax applied to upper income categories can temporarily be “graduated” by 1% per $5,000 earned, up to a higher threshold as voted in by Congress; and (b) the percentage applied per income range can temporarily be increased by .1-.25%, so all taxpayers shoulder the burden of the economic cost of war.
- The separate calculation for investment categories of income will encourage investment into our economy and allow the middle class to save for their own families’ needs, retirement, education, mortgage, health care and similar savings needs, without relying on government help or tax credits (Pell grants, Social Security, Medicaid, mortgage payment deduction).
- The IRS should be substantially reduced – far fewer personnel needed to collect taxes, answer questions, write and publish forms, conduct audits, etc.
- The plan could be implemented to end the marriage penalty (see Scenario 2 below).
- Taxes for young people just getting started in their careers and retired individuals would generally be substantially less at a time when they need to keep more of their income.
- There is no opportunity for fraudulent claims of tax credits, exemptions, and deductions.
- Inheritance will no longer be “double taxed.” These assets were already taxed when they were earned by the benefactor! The beneficiaries should not also have to pay a tax on the same assets.
The Graduated Income Tax Proposal:
The following chart and sample scenarios outline how this proposed graduated income tax would work.
The various categories of income would be taxed separately: earned income (wages, salary, tips), interest income, dividends, capital gains, lottery and gambling winnings, business income (net profit), etc.
|Income Range||Percent tax||Maximum tax for income range||Maximum total tax||Tax as % of total income|
Scenario 1 – A household with the husband earning $35,600 and the wife earning $13,480, husband’s interest income of $149, wife’s dividend income of $2,356, and husband’s capital gains of $4,387 (all income is calculated as though jointly received).
tax on earned income of $49,080 is $950 + 6% of $4,080 ($244.80) = $1,194.80
tax on interest income is 1% of $149 = $1.49
tax on dividends is 1% of $2,356 = $23.56
tax on capital gains is 1% of $4,387 = $43.87
Net federal tax = $1,263.72
Scenario 2 – Same as Scenario 1, except that earned income is calculated separately for the husband and the wife. Note: This scenario illustrates the benefits to a family if we abolish the marriage penalty and requirement for income to be considered “joint.” Each calculation would be made separately for the husband’s earnings, interest, dividends, etc. and the wife’s earnings, interest, dividends, etc.
tax on $35,600 is $500 + 4% of $600 ($24) = $624
tax on $13,480 is $134.80
tax on interest, dividends, and capital gains is same as Scenario 1
Net federal tax = $827.72
Scenario 3 – A retired couple with the husband receiving $35,888 per year from Social Security, the wife withdrawing $4,500 a year from her IRA, and the couple receiving $12,500 per year from a joint mutual fund account (capital gains).
tax on Social Security payments = $0
tax on IRA withdrawal of $4,500 = $45
tax on capital gains = $125
Net federal tax = $170
Scenario 4 – A business owner with $780,000 in profits, $48,000 in dividend income (from municipal bonds), and $23,000 in capital gains.
tax on business profits is $5,400 + 15% of $690,000 = $108,900
tax on dividends is $250 + 6% of $3,000 ($180) = $430
tax on capital gains is $230
Net federal tax = $109,560
[Note: this is 12.87% of total income]
Scenario 5 – A retired military veteran with a second career earns 34,600 in military retirement, 45,700 in his job, and withdraws $4,600 a year from his Roth IRA ($3,580 principle and .
tax on military retirement = 0
tax on current job = $950 + 6% of $600 = $986
tax on Roth IRA = $0 for withdrawal of contributions, 1% of interest earnings = $10.20
Net federal tax = $996.20
Scenario 6 – A self-employed teenager with a lawn care business earns $3,765 for his summer work, after deducting his costs for equipment purchases and repair, oil and gasoline, and travel to job sites. This teen also earned $65 interest on his Education Savings Account and $35 interest in a matured Certificate of Deposit.
tax on business profits = $37.65
tax on ESA = $0 (interest earnings on ESAs are non-taxable)
tax on matured CD = $.35
Net federal tax = $38
Scenario 7 – A man age 47 receives an inheritance from his grandfather of his portion of the family ranch, valued at $450,000, and his portion of his grandfather’s IRA, valued at $60,000, which he rolls over into an approved account. The man also has $95,000 of earned income and $3,500 of capital gains in that calendar year.
tax on inheritance (property) = $0 (real property inheritance is not taxable)
tax on inheritance (IRA) = $0 (the inherited IRA assets will be taxable when they are withdrawn)
tax on earned income = $5,400 + $750 = $6,150
tax on capital gains = $35
Net federal tax = $6,185
Questions to be Answered
- Expert in federal budgeting would need to “run the numbers” to ascertain how much revenue this tax system would generate. Keep in mind that our nation has a spending problem, not a revenue-generating problem. Our government can learn to “live within its means” under a fair tax system such as the one I propose.
- A streamlined set of guidelines for business expense deductions also has to be developed so businesses are fairly taxed for profits, but not prevented from investing capital into their businesses, hiring staff, etc.
- Clarification will need to be established regarding treatment of inheritance that is taxable in the future, such as IRAs and ESAs, to ensure compliance with existing laws governing those types of accounts.