Philarious Rex
Taxation without Obfuscation

I’ve had taxes on the brain lately. For one thing, I just filed my 2011 return. For another, I was at a real estate industry conference earlier in the week, and believe me when I tell you that the industry is in histrionics over the idea that so-called “carried interest” might ever again be taxed at “regular” rates instead of the (lower) capital gains rate. (For an explanation of how this works, here’s an article a co-worker forwarded me. Full disclosure: under our current tax system, I’m actually pretty uncomfortable with this. But the article does explain the rationale.) And, of course, we had the nonsense in the State of the Union Address about Warren Buffet and his secretary, which was rhetorically very misleading but did put the issue of “fairness” in taxation front and center.

A Self-study

In light of all the commotion about the effective tax rates paid by people like Buffet and Mitt Romney, I got curious. What has my effective tax rate been? How do I compare to these “One Percenters?” I’m almost certain that the figures we’ve seen in the news are talking about Federal income taxes, as distinct from payroll taxes and state income and sales taxes. Using that as the standard, I looked at my returns since 2008 because my total income has been relatively consistent since then. Here are some interesting figures about my tax situation:

Folks, this makes no sense. Why should my tax rate have varied so much? Heck, why should it be so low? I can explain it all, of course. The main reason for 2009’s low effective tax rate is the asinine Home Buyer Tax Credit. And for the last couple of years, I’ve taken advantage of a bigger mortgage (which means a higher mortgage interest deduction) and saving more in tax-sheltered accounts like 401(k)s and HSAs. Essentially, I’m learning to game the system. So I understand why the differences exist. But it is absurd that they should exist. More than that, it’s unfair.

I know there are many, many families of four with incomes similar to mine who are not afforded the opportunity to take advantage of the tax breaks that I get. In some markets, getting a down payment together to own a home is a pipe dream. There goes the mortgage deduction. And while most employers offer tax-deferred retirement accounts, not all do. Of those that do, not all are as generous as the 401(k). Regardless, it’s a lot harder to make those contributions to a 401(k) - or, for that matter, to a charity - if you’re paying more in taxes in the first place because you don’t have mortgage interest to deduct. It builds on itself.

A Solution

The more I’ve considered this issue, the more I am drawn to the Fair Tax. It strikes me as simple, efficient and true to it’s “fair” name in the sense that it is mildly progressive without the Robin Hood element. It is well worth the investment of a few minutes to research. One thing I like about it is what it eliminates:

  • Estate Taxes - I consider these to be immoral because the money involved was already taxed when it belonged to the bequeather. Furthermore, it has often led inheritors to sell assets in order to pay the tax (Miami Dolphins fans will know all about this). Where’s the fairness in that? The class-envy crowd doesn’t like the idea of wealthy heirs and heiresses getting “free” windfalls, but my answer to that is that, under the Fair Tax, these people actually will pay taxes - and possibly more taxes - on this money when they spend it.
  • Corporate Income Taxes - There are several good reasons to favor abolishing corporate income taxes. For one thing, there’s another double-taxation issue. Company owners and investors have to pay tax on dividends they receive, so why make the company pay taxes on the same profits first? (This concept is the genesis of Romney’s ill-fated “corporations are people” line.) For another thing (and I know this from first-hand experience), companies manage their “on-paper” profits to minimize their taxes. This creates perverse incentives, not to mention a lot of time and energy that would be better spent running the companies themselves. And that doesn’t even begin to account for the time and energy spent on collections, investigations, enforcement, etc. But there is another reason to eliminate corporate income taxes, and it is a populist one. The minute corporate income taxes are eliminated, the power of K Street is emasculated. This is why I’m perplexed by the political left’s resistance to the Fair Tax. They often point out that a few large, powerful business interests have too much corrupting power and influence over the political process. They’re not wrong. But the reflexive response to “make them pay” is misguided. The largest, most powerful companies are precisely the ones who can afford to carry the burden of dealing with a complex corporate income tax system. It’s the smaller ones who end up suffering disproportionately. Getting rid of the corporate income tax strips  a lot of power from our country’s back-room oligarchy.
  • Capital Gains Taxes - This is the one I am the least passionate about because I do believe that income is income. Under the Fair Tax, which is consumption-based instead of income-based, I agree with killing the capital gains tax. But under an alternative system like a flat tax (itself far superior to the current system), it should still exist. Herman Cain’s 9-9-9 plan is an example of one that would equalize the rate on all personal income, whether from wages or “investments.” The response to criticisms of inequity here would be along similar lines to the elimination of the estate tax. As a country, we don’t want to discourage investment. And while it’s true enough that wealthy people benefit a lot from capital gains, it’s also true that what they do with their money benefits the economy a great deal under a plan like the Fair Tax. They either reinvest it (which means giving it to businesses or governments to help them grow), save it (which means giving it to banks to let them lend) or spend it (which, under the Fair Tax, means they would pay a higher rate than the current capital gains rate anyway). Besides, isn’t it the conspicuous consumption of the wealthy that’s really behind all the class envy of the 99%? Under the Fair Tax, the wealthy will always pay extra for that consumption.
  • Payroll Taxes - I consider the payroll tax to be near-criminal in its regressiveness. For the life of me, I can’t understand why any populist (liberal or conservative) would find the Social Security portion of this tax remotely acceptable. It ought to be the easiest thing in the world to reform. Maybe some people are still living under the “it’s a savings account for your future” fantasy. Whatever. Why should anyone pay less in taxes once their income gets into the six figures? Short answer: they shouldn’t.

There would certainly be a difficult adjustment in our economy if retail prices were to jump by 25% all of a sudden to accommodate a national sales tax. And there would be a significant shakeup in the careers of accountants, corporate lawyers and lobbyists. But I think the benefits would far outweigh these costs. Perhaps the biggest challenge would be teaching a lot of people who have never filed an income tax return that they now should file for a monthly “prebate” (the Fair Tax’s mechanism for exempting a certain base amount of subsistence spending from taxation). In fact, I wonder if a great deal of the resistance on the left isn’t really about people who wouldn’t want to be “found” through the filing process - undocumented resident aliens. I have some ideas about that too, but those are for another post.