3. The Postcard Tax Return - Hoover Institution

1 Hoover Classics : Flat Taxhcflat ch3 Mp_79 rev0 page 793. The Postcard Tax Returntax formsreally can fit on postcards . A cleanly de-signed tax system takes only a few elementary calcula-tions, in contrast to the hopeless complexity of today sincome taxes. In this chapter, we present a completeplan for a whole new tax system that puts a low tax rateon a comprehensive definition of income. Because itsbase is broad, the astonishingly low 19 percent tax rateraises the same revenue as does the current tax tax on families is fair and progressive: the poor payno tax at all, and the fraction of income that a familypays rises with income. The system is simple and easyto understand.

2 And the tax operates on the consumptiontax principle families are taxed on what they take outof the economy, not what they put into system rests on a basic administrative principle:income should be taxed exactly once as close as possibleto its source. Today s tax system violates this principlein all sorts of ways. Some kinds of income like fringebenefits are never taxed at all. Other kinds, like divi-dends and capital gains, are taxed twice. And interestincome, which is supposed to be taxed once, escapestaxation completely in all too many cases where clevertaxpayers arrange to receive interest beyond the reach ofthe our plan, all income is taxed at the same of tax rates is a basic concept of the flat tax.

3 ItsHoover Classics : Flat Taxhcflat ch3 Mp_80 rev0 page 8080 The Flat Taxlogic is much more profound than just the simplicity ofcalculation with a single tax rate. Whenever differentforms of income are taxed at different rates or differenttaxpayers face different rates, the public figures out howto take advantage of the differential. The basic trick isto take deductions at the highest available rate and toreport income at the lowest rate. Here are some of theways that the trick can be applied: A company pays its workers partly in the form ofstock options because the options will eventually betaxed at lower capital gains rates. A real estate operator borrows from a bank and de-ducts the interest at his 40 percent marginal rate;the interest received by the depositors at the bankis taxed at their lower rates.

4 An author arranges for royalties to be deferred tonext year because she knows that she will be in alower tax bracket next year. A corporation pays its shareholders exaggerated sal-aries as officers because salaries are taxed only oncebut dividends are taxed twice. A company gives its workers prepaid legal servicesas a nontaxable fringe benefit, in place of cash thatwould be plan would sweep away all these inequities andinefficiencies. None of these opportunities to escapetaxes by distorting economic choices would survive Classics : Flat Taxhcflat ch3 Mp_81 rev0 page 8181 The Postcard Tax Returnprogressivity, efficiency, and simplicityLimiting the burden of taxes on the poor is a centralprinciple of tax reform.

5 Some ideas for tax simplificationand reform flout this principle neither a federal salestax nor a value-added tax is progressive. Instead, all cit-izens, rich and poor alike, pay essentially the same frac-tion of their spending in taxes. We reject sales andvalue-added taxes for this reason. The current federaltax system avoids taxing the poor, and we think it shouldstay that the poor from taxes does not requiregraduated tax rates rising to high levels for upper-incomefamilies. A flat rate, applied to all income above a gen-erous personal allowance, provides progressivity withoutcreating important differences in tax rates. Graduatedtaxes automatically create differences in tax rates amongtaxpayers, with all the attendant opportunities for taxavoidance tricks.

6 Because it is high-income taxpayerswho have the biggest incentive and the best opportunityto use special tricks to exploit tax rate differentials, ap-plying the same tax rate to these taxpayers for all theirincome in all years is the most important goal of flat-rate proposal is based squarely on the principle ofconsumption taxation. Saving is untaxed, thus solvingthe problem that has perplexed the designers of the cur-rent tax system, which contains an incredible hodge-podge of savings and investment incentives. As a generalmatter, the current system puts substantial taxes on theearnings from savings. On that account, the economy isHoover Classics : Flat Taxhcflat ch3 Mp_82 rev0 page 8282 The Flat Taxbiased toward too little saving and too much consump-tion.

7 But Congress has inserted a number of special pro-visions to spur saving. Most important, saving for retire-ment is excused from current taxation. Workers are nottaxed on the amount their employers contribute to pen-sion funds, and the employers can deduct those contri-butions. The self-employed can take advantage of thesame opportunity with Keogh, individual retirement ac-count (IRA), and simplified employee pension (SEP)plans. The overall effect of the existing incentives isspotty there are excessive incentives for some saving-investment channels and inadequate incentives for oth-ers. In our system, there is a single, coherent provisionfor taxing the Return to saving.

8 All income is taxed, butthe earnings from saved income are not taxed will explain how this works later in the believe that the simplicity of our system is acentral feature. Complex tax forms and tax laws do moreharm than just deforesting America. Complicated taxesrequire expensive advisers for taxpayers and equally ex-pensive reviews and audits by the government. A com-plex tax invites the taxpayer to search for special featuresto exploit to the disadvantage of the rest of us. And com-plex taxes diminish confidence in government, invitinga breakdown in cooperation with the tax system and thespread of outright integrated flat taxOur flat tax applies to both businesses and our system has two separate tax forms oneHoover Classics : Flat Taxhcflat ch3 Mp_83 rev0 page 8383 The Postcard Tax Returnfor business income and the other for wages and sala-ries it is an integrated system.

9 When we speak of itsvirtues, such as its equal taxation of all types of income,we mean the system, not one of its two parts. As we willexplain, the business tax is not just a replacement forthe existing corporate income tax. It covers all busi-nesses, not just corporations. And it covers interest in-come, which is currently taxed under the personal in-come our system, all income is classified as either busi-ness income or wages (including salaries and retirementbenefits). The system is airtight. Taxes on both types ofincome are equal. The wage tax has features to makethe overall system progressive. Both taxes have postcardforms. The low tax rate of 19 percent is enough tomatch the revenue of the federal tax system as it existedin 1993, the last full year of data available as we is the logic of our system, stripped to basics:We want to tax consumption.

10 The public does one oftwo things with its income spends it or invests it. Wecan measure consumption as income minus really simple tax would just have each firm pay taxon the total amount of income generated by the firmless that firm s investment in plant and equipment. Thevalue-added tax works just that way. But a value-addedtax is unfair because it is not progressive. That s why webreak the tax in two. The firm pays tax on all the incomegenerated at the firm except the income paid to its work-ers. The workers pay tax on what they earn, and the taxthey pay is measure the total amount of income generatedHoover Classics : Flat Taxhcflat ch3 Mp_84 rev0 page 8484 The Flat Taxat a business, the best approach is to take the total re-ceipts of the firm over the year and subtract the pay-ments the firm has made to its workers and approach guarantees a comprehensive tax successful value-added taxes in Europe work thisway.