For more information contact David E. Vance, Clinical Assistant Professor, Rutgers School of Business Camden

Transcription

1 Tax Reform The economy grows fastest when everyone has the maximum incentive to work save and invest. Taxation reduced incentives, but taxes are needed to run the government. The balance between incentives and taxes can be achieved when taxes are (i) simple to calculate, (ii) few in number, (iii) with the widest possible base, and (iv) the lowest possible rate. Tax complexity reduces incentives without raising revenue. Complexity is driven by four factors (i) use of the tax system for social engineering, (ii) elaborate schemes to chase small amounts of revenue, (iii) rules designed to increase fairness which simply pick winners and losers and (iv) poor drafting. The personal income tax code has become so complex neither taxpayers, professional tax preparers, nor the Internal Revenue Service can apply it on a consistent basis. 1 Research has shown that whether marginal rates are high or low, the federal government harvests about twenty percent of gross domestic product. 2 Therefore, it should be possible to reduce tax rates, grow the economy and allow the government to harvest twenty percent of a bigger gross domestic product thus increasing government revenue. This paper proposes a clear simple tax plan that should raise as much or more tax revenue than the current code without reducing incentives to grow the economy. The rational for each section of the proposed tax code is followed by suggested statutory language. Personal Income Tax Many problems in the personal income tax code stem from credits, deductions, exemptions and other devices designed for behavior modification and social engineering. The tax code should be limited to raising revenue for the government. Complexity also arises because some income is treated differently than other income, for example interest on municipal bonds is not currently taxed. Capital gains provisions and provisions allowing taxpayers to use losses to offset income give rise to complicated and unproductive tax shelters. There is no reason why the government should subsidize bad investment choices by allowing losses to off-set income. Finally, phase outs and conditional tests add further complexity. Section 01 Personal Income Tax 1.1. All tax credits, deductions, exemptions, capital gains, losses and loss carry-forwards and the Alternative Minimum Tax are repealed. Business losses, casualty losses, loss on sales of assets or other losses may not be used to offset income Income is income from all sources including by not limited to wages, salaries, bonuses, income from sole proprietorships and the allocated share of partnership profits, distributions from trusts and estates, gain on sale of real, personal and intellectual property, interest, dividends, stock rights and warrants and interest on municipal bonds and alimony received. Income shall include unemployment compensations, workers compensation to the extent it is a wage replacement, and half of Social Security. Only income earned in the United States, its possessions, territories and dependencies shall be included in income There shall be a personal exemption of $5,000 for the taxpayer and a $5,000 exemption for each dependent.

2 1.4. Court ordered alimony actually paid may be deducted from income Taxable Income is Income less personal exemptions and alimony The tax on the first $40,000 of taxable income is 5%; on taxable income from $40,000 to $200,000 is 10%; on taxable income from $200,000 to $1,000,000 is 15%; on taxable income from $1,000,000 to $5,000,000 is 20%; and on taxable income above $5,000,000 is 25%. Multiple tax brackets don t make the tax code complicated. All the calculations needed to get to taxable income make it complicated. Proposed tax rates are roughly similar to rates currently paid on incomes up to $200,000, slightly less than the tax rate on incomes from $200,000 to $1,000,000 and much higher than current effective tax rates on income over $5,000,000. Corporate Income Tax Complexity in corporate income taxes arises from credits, deductions, accelerated depreciation and other provisions designed to encourage or discourage behavior and to favor or disfavor certain industries rather than generating tax revenue for the government. Such provisions distort economic outcomes as companies focus on minimizing taxes rather than selling goods and services. Such provisions necessitate keeping two sets of books, one to compute taxable income and one to report economic income, and of course those books must be reconciled. United States tax rates are among the highest in the world which discourages investment and expansion. The government s attempt to chase worldwide profits on United States based businesses adds cost and complexity to tax administration and makes it irrational to start or grow a business in the United States if other options are available. The tax code could be simplified and overseas profits repatriated to the United States for distribution and reinvestment if only domestic income was taxed. Start-up businesses create most of the jobs in the economy and entrepreneurs should have the maximum incentives to start and grow businesses. This implies that smaller businesses should be very lightly taxed, with rates only reaching maximum levels for the very largest businesses. Section 02 Corporate Income Tax 2.1. All tax credits, exemptions, capital gains, losses and loss carry-forwards, accelerated depreciation, bonus depreciation, and depletion in excess of cost are repealed Taxable income is net income based on Generally Accepted Accounting Principles, subject to the limitations of paragraph 1 above, plus compensation for any executive, employee or board member in excess of $2 million per year. 2.3 The tax rate on the first $5 million of taxable income is 5%; on taxable income from $5 million to $50 million is 10%, on taxable income from $50 million to $500 million is 15% and on taxable income over $500 million is 20% Corporate income earned after the date this code is effective will only be taxed if earned within the United States, its possessions, territories and dependencies.

3 2.5. The tax on corporate income earned outside of the United States and before the date this code is effective will be 5% if repatriated to the United States within one year of this code becoming effective. Earnings shall be deemed repatriated on a First Earned, First Repatriated basis. The tax on income earned outside of the United States prior to the implementation of this code, and repatriated more than one year after the effective date of this code shall be taxed at a 35% rate with no offset for taxes paid to other jurisdictions. Unincorporated Businesses Unincorporated businesses should be treated in a manner similar to corporations. Section 03 Unincorporated Businesses 3.1 All tax credits, exemptions, capital gains, losses and loss carry-forwards, accelerated depreciation, bonus depreciation, and depletion in excess of cost are repealed. 3.2 Taxable income is net income based on Generally Accepted Accounting Principles, subject to the limitations of paragraph 1 above, plus compensation for any executive, employee or board member in excess of $2 million per year. 3.3 Income from a sole proprietorship shall be income to the owner. Losses may not be passed through to the owner. 3.4 Income from partnerships shall be allocated to partners and each partner will pay tax on his, her or its allocated share. Losses may not be passed through to partners. Excise Taxes Excise taxes are generally conceived of as taxes to pay for government services. For example, the gasoline tax is supposed to pay for roads and the tax on airline tickets is supposed to support airport infrastructure. The excise tax on cigarettes is designed to discourage smoking although it helps offset increased health costs. There are other excise taxes which add complexity and administrative cost without raising significant revenue. Simplicity and tax efficiency could be gained by limiting excises taxes to three. Section 04 Excise Taxes 4.1. The excise tax on gasoline and diesel fuel sold for use on public roads shall be $.25 per gallon The excise tax on airline tickets shall be 10% of the ticket price. The tax shall not apply to ancillary services such as meals or checked bags Tobacco products shall be taxed at the rate of $5.00 per pound All other excise taxes are repealed.

4 Social Security and Medicare Taxes Social Security and Medicare taxes are necessary to honor the social bargain between those in the workforce and those no longer working. However, these taxes should not be so heavy that they discourage work and reduce tax contributions. Section 05 Social Security and Medicare Taxes 5.1. Employees will be taxed 6.0% of the first $200,000 of wages, salaries and bonuses for Social Security. Employer s will pay an amount equal to the tax paid by employees Employees will be taxed 1.5% of the first $200,000 of wages, salaries and bonuses for Medicare. Employers will pay an amount equal to the tax paid by employees Self-employed individuals will pay both the employee and employer taxes. However, employer taxes will be a tax-deductible business expense. Trusts and Estates Trusts and estates should not be used as a vehicle to avoid taxation. Section 06 Trusts and Estates 6.1 Trusts and estates shall pay tax on undistributed earnings at the same rate as individuals. However, they may not use personal exemptions. Gift, Inheritance and Other Taxes Gift and inheritance taxes are taxes on money that has already been taxed. The very find ways to pass on wealth through a number of devices including memberships on foundation boards and so forth. Gift and inheritance taxes fall most heavily on family businesses including family farms. It should be the policy of the government to encourage production which will ultimately result in jobs and taxable income, not burden passing wealth to family members and others. Other federal taxes increase administrative cost and add complexity without raising substantial revenue and should be repealed. Section 07 Gift, Inheritance and Other Taxes 7.1 Gift and inheritance taxes are repealed All other federal taxes are repealed.

5 Administration The Internal Revenue Service slows economic growth by burdening taxpayers with endless demands for data and information, some of which is only tangentially related to collection of taxes. Section 08 Tax Administration 8.1 The Internal Revenue Service will only collect the information needed to compute taxes, or otherwise required by this tax code. Taxpayers shall maintain records sufficient to permit verification that taxes were properly paid. 8.2 The statute of limitations for assessment of taxes and penalties is three years from the date tax returns were filed. Tax returns may not be audited more than three years after the date of filing. The statute of limitations is extended to five years if taxes due and owing were under reported by more than 20%. 8.3 Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof, shall, in addition to other penalties provided by law, be guilty of a felony. A taxpayer convicted of criminal fraud is subject to a fine of up to $100,000 ($500,000 in the case of a corporation, but not less than three times the tax underpayment) or imprisonment of up to five years. 8.4 The Internal Revenue Service will at all times respect due process in the assessment and collection of taxes and may not seize any assets without a court order. 8.5 Income computed using Generally Accepted Accounting Principles as limited by this statute and audited by a Certified Public Accountant shall be entitled to a presumption of correctness. Such presumption may only be overcome by clear and convincing evidence. 1 Is the Federal Income Tax Code Unconstitutionally Vague, Mustang Journal of Law and Legal Studies, October Unconstitutional Vagueness and the Tax Code, Tax Notes Vol.143. No. 7. May 19. Pp Hauser, Kurt W. and David Ranson Hauser s Law, Hoover Digest No. 4. Oct This essay appeared in the Wall Street Journal on May 20, 2008.