Can We Make Taxes More Fair?

If there is one entity that is despised more than any other in the United States it is probably the Internal Revenue Service (IRS). It is the agency responsible for taking money out of our paychecks and ensuring that people pay up when their tax bill comes due. The tax code is thousands of pages long and gets longer every year.

Any dollar you earn is subject to taxation in one form or another. Examples include:

• Retirement accounts are taxed when the money hits your bank account
• Wage income
• When someone dies taxes are paid on the estate
• Excise taxes exist on certain goods
• Once you earn Social Security you pay tax again 
• You pay taxes on investments (called capital gains taxes).
• You pay tax on money earned outside the US 
• Corporations pay up to a 35% tax rate on their profits 

Social Security and Medicare tax are slightly different. You pay half of the 15.3% tax requirement up to a certain income amount and your employer pays the other half in the form of payroll taxes.

The above is a very simplistic view of how our current tax system works. People are frustrated with the IRS and the tax code because it doesn't appear to be transparent or fair. I have seen examples of a person making twice the salary I do pay a tax percentage that is actually lower than mine. Why would this be?

• People who earn more are more likely to use their money in such a way that would qualify them for exemptions or deductions
• People who are wealthy enough and make their money through dividends and investments are taxed at a lower rate than standard wage income (15%)
• Those with wealth and influence convince lawmakers to give their enterprises or themselves a tax deduction through lobbying
• Those who make less income have a greater impact to their take home monies due to the Social Security and Medicare tax - small businesses take a big hit since they pay the entire 15.3% rate.

Another reason people complain is that the money paid in salaries and the cost of goods doesn't accurately reflect their real value. Companies seek to ensure they keep their profit margins first and usually compensate for their overhead costs by passing them onto consumers in the form of price increases, moving their operations outside the country, or cutting wages.

Are there alternatives to this system? There are a couple being proposed by grass roots elements: a Flat Tax and what is called the Fair Tax. 

A flat tax would apply to all forms of income above deduction and exemption amounts at the same rate. This method simplifies overhead, but doesn't eliminate the SS/MC tax or any other component within the existing tax infrastructure. According to the chart below, higher income people would pay a lower total tax percentage than the poor because social security tax is not paid above certain income amounts (Flat Tax rate of 15%):

Taxable Income (inc standard deductions)	Flat Income Tax	Flat Real Tax Rate
20000	3000	22.65%
30000	4500	22.65%
50000	7500	22.65%
75000	11250	22.65%
100000	15000	22.65%
250000	37500	19.53%
500000	75000	18.44%

This method could be improved by eliminating "special" deductions, raising the tax threshold to the 15% tax bracket, or reducing the tax rate. Currently however, proponents would leave the current deduction and tax collection apparatus in place.

The third method is called the "Fair Tax," a completely different method of raising revenue. Instead of taxing income, end point consumer spending is taxed instead. An individual keeps their entire paycheck and any tax owed is discretionary. Certain spending is not taxed, including:

• Charitable donations
• Money spent paying debts (not credit card debt)
• Any item considered "used" - any item that had tax paid on it before is not taxed again
• School tuition
• State income and sales taxes

It is argued that the Fair Tax is naturally progressive since those who earn more will spend more and will spend on "higher class" goods. 

The Fair Tax also includes what is called a "prebate." Depending on the size of your household, you receive a check from the government that "preempts" tax you will pay on goods and services that month. The prebate is larger for bigger households (much like a deduction) but every household gets a check. The benefit is lower income individuals and families spending total money at or below the poverty line pay no tax at all. The prebate is not paid to people who aren't residents of the US (including illegal immigrants).

Another argument in favor of the Fair Tax is that the only overhead incurred is ensuring that businesses collect and pay the tax itself and that businesses pay tax on what would be considered "consumption". There are no payroll taxes, social security taxes (Social Security and Medicare is included in the actual tax rate), etc. and there is no tax paid in the manufacturing of an item, only its consumption. The price at market would thereby be more accurately reflected and an individual can see just how much they have to pay to support the Federal government. The reasoning behind this is that businesses pass the tax they owe to the consumer, so the actual tax incurred is hidden.

As far as the government itself is concerned, the Fair Tax calls for the elimination of the IRS as sales tax collection infrastructure is already well established. The state tax agency would collect the federal tax and pass it along to the US Treasury. Lobbying groups also lose their bargaining power.

According to fairtax.org, in order to maintain the current level of revenue generated by income and social security taxes, the FairTax rate would be 23%.

What are the drawbacks if any?

• Tax is collected only at the point of consumer purchase and licensed businesses are free to make business transactions tax free - it may be more difficult than it is claimed to ensure compliance
• All goods consumed are taxed including food, medication, and utilities which are often exempt from state sales taxes; see how much your "free spending prebate" would help you here.

There are plenty of tax calculators online - but if you want to see how different tax schemes would impact you visit:

Current method: IRS Tax Calculator

Use the following equation to determine your real tax rate:

(federal income tax + (total income x .0765)) / total income

For the flat tax, use the following equation:

(taxable income x (.15 + .0765)) / total income

To determine how much money you could owe via the Fair Tax use the Fair Tax Calculator

Decide for yourself what method of taxation would benefit you best and talk to your legislators about it.

Happy Weekend!