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Author: MadCapitalist Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 737106  
Subject: OT: The MadCapitalist Tax Reform Act of 2007 Date: 1/20/2007 6:09 PM
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Exactly. I'm always amused by people who A) are vocal proponents of a flat tax who B) raise their voices in protest at AMT. Not you, obviously, but some other people.

-synchronnicity

http://boards.fool.com/Message.asp?mid=25062961

This quote by synchronicity (who apparently has trouble spelling his own name) on the AMT thread made me think. *I* am a vocal proponent of the flat tax, and *I* raise my voice in protest at the AMT, so synchronicity must find me amusing. I'm not sure why it is amusing. The fact that someone wants a flat tax in no way suggests that the person likes having two parallel tax systems that add complexity, complicate tax planning, and increase the amount of income tax that is due.

In any event, I would *love* a flat tax (assuming a *single* system of taxation), but my own preferred version is much different from anything that I have ever heard suggested before.

I present to you my proposal for the MadCapitalist Tax Reform Act of 2007 (which will no doubt be extremely controversial).

Here are the main factors of my system:
1) One flat tax rate that applies to all forms of income at all income levels, and *no* exemption amount.
2) Only allowed deductions for expenses related to the production of income, *no* deductions for personal expenses, *no* tax credits, and *no* tax-free income.
3) The corporate income tax would be changed to the flat tax rate, and the tax on corporate dividends would be eliminated.
4) The estate tax would be eliminated, although income tax would be due on inheritances received.
5) The taxes on Social Security and Medicare would be eliminated.

Here are more details and my reasoning for these factors.

# 1 - One flat tax rate that applies to all forms of income at all levels, and *no* exemption amount.

This is a very important aspect of my tax system. *Everyone* who has income would pay income tax under my system, and everyone would pay it at the same rate (I can hear liberals gasping already). The reason that this is so important is because if anyone thinks that a tax increase is such a hot idea, he should be willing to pay more tax himself. We currently have a tremendous number of people who think that a tax increase is a great idea, as long as the tax increase is on someone else. It is very easy to be generous when you are being generous with other people's money. If someone wants to be self-righteous and criticize the greed of others, then let them demonstrate their own generosity by subjecting themselves to the same tax rate increase that others are subjected to.

A single rate would also reduce much of the tax maneuvering that currently occurs. No one would have to worry about whether capital gains are short-term or long-term (and I would allow the cost basis to be indexed for inflation, since it isn't fair that people have to pay taxes on gains from inflation). You could sell based on the economics of the situation without worrying about how the calendar is going to affect your after-tax return. Why does Uncle Sam care so much about how long you own an investment anyway? Also, you would avoid the gyrations with trying to time your income to occur in low-income years and your expenses to occur in high-income years, because there would only be one tax bracket, and it would have no impact on your tax rate. There would be no marriage penalty, because there would in fact be no need for the different filing classifications (i.e. single, head-of-household, married filing jointly, married filing separately, or qualifying widow(er) with dependent child). There would not be any tax brackets or exemptions, so it would make absolutely no difference how someone filed.

#2 - Only allowed deductions for expenses related to the production of income, *no* deductions for personal expenses, *no* tax credits, and *no* tax-free income.

It is appropriate that deductions would be allowed for expenses related to the production of income. This would include business expenses, investment expenses, and employee expenses. I would scrap the current limitations on deductions for these expenses. I would also allow a deduction for education expenses (including college expenses) related to one's career or investments. However, the cost of education courses not related to the person's career or investments (such as “general education” classes that colleges usually require) would not be deductible. Also, the deduction for career education expenses would only be allowed once the person actually began working in the profession.

One reason for the prohibition against personal expenses, tax credits, and tax-free income is that I am against the social engineering that our politicians currently attempt. The current tax code is replete with incentives to reward us for behaviors that politicians deem noble, desirable, or somehow deserving of compensation, with the practical (although somewhat hidden) effect of punishing those who do not engage in those behaviors. Granting these incentives means that the tax rate must be higher than it would have been otherwise to generate the same level of tax revenue, so those that do not benefit from the incentives end up paying more tax in order to subsidize those that do benefit.

For example, renters subsidize homeowners (the mortgage interest and real estate deductions, as well as the capital gains exemption). Healthy people subsidize sick people (the medical expense deduction). People without children subsidize parents (additional personal allowances, the earned income tax credit, etc.). People who do not give to charity subsidize those that do (charitable deductions). People who live in states or localities with low income taxes and property taxes subsidize people who live in states or localities with high income taxes and property taxes (through the federal deduction for state and local taxes). The list goes on and on and on. I am totally against the government trying to use tax policy to promote or discourage behaviors that conflict with the values of those in power. I don't think that this is a proper function of government. The government's proper function is to protect our rights, not to give the majority a tool through which they can influence us (or force us) to live the way they think we should live.

There would not be any more contributions to retirement plans because contributions would no longer be deductible and there would not be any tax deferral any longer, except for assets that are already in retirement plans. All investment income would be taxable currently at the one low flat tax rate that applies to all other income. I am sure that this proposal would be especially controversial, since there is so much talk about encouraging savings. However, one reason for this (as well as the disallowance of other tax-free income, deductions for personal expenses, and tax credits) is to expand the tax base as much as possible. This would minimize the tax rate that would be required to generate the necessary tax revenue.

I am a huge believer in keeping marginal tax rates extremely low. High marginal rates have very powerful perverse effects on our economy (a fact that I'm amazed that liberals can continue to ignore). High marginal rates punish savings, business investment, and working in a very significant way. This shouldn't be surprising. If I'm an entrepreneur, I am going to look at the potential after-tax return that I could possibly earn from starting a new business as well as the risk involved. By significantly reducing after-tax returns, high marginal tax rates significantly reduce the number of business opportunities that are pursued for any given level of risk. The result is that fewer jobs are created and less value is created for consumers. Employees will also be encouraged to work less when marginal rates are high. The economy loses the value that they would have created.

High marginal rates also dramatically increase incentives for tax evasion and the pursuit of legal tax strategies. People are much more willing to break the law to avoid paying 50% of their income in taxes compared to 15%, and they are much more willing to pay for expensive tax attorneys and tax accountants if their marginal tax rates are 50% rather than 15%. This is an incredible dead-weight loss to society. The government loses revenue from tax evaders and must incur increased expenses catching them, prosecuting them, and imprisoning them. Meanwhile, society loses the value that the additional tax attorneys and tax accountants would have produced if they were employed in ways that were more productive to society. What a waste!

#3 - The corporate income tax would be changed to the flat tax rate, and the tax on corporate dividends would be eliminated.
My proposal would eliminate the double taxation of corporate income. Currently, the combined tax rate for the corporate income tax and dividend tax is 50% (35% plus 15%), so the tax rate would be reduced dramatically. Many economists consider the corporate income tax one of the most economically destructive taxes we have, and I agree. My proposal would *dramatically* improve the competitive position of US companies on a global basis, would increase investment and employment, would increase investment returns, and stock values.

Philosophically, dividend “income” wouldn't be considered income, but rather a return of capital. This is how distributions to owners are currently treated in “pass-through” entities such as sole proprietorships, partnerships, and S-corporations. Tax on pass-through entities is paid on income as it is earned rather than when cash is paid out to owners. With pass-through entities, each owner reports their share of the income or loss on their personal tax return. For my corporate income tax proposal, income tax would be paid at the corporate level (as it is now) instead of being passed through to the owners. My reason for this is practical. With shares of corporations changing hands so often, it would be an administrative nightmare to report the pass-through income to the owners.

#4 - The estate tax would be eliminated, although income tax would be due on inheritances received.
Under my proposal, the estate tax would be eliminated. Instead, inheritances and gifts would be taxable to the person who receives them at the low flat rate. If the deceased bequeathed assets with unrealized gains or losses, the gains or losses would be treated as realized on the deceased's final tax return. Currently, there is an annual exclusion for gift taxes of $12,000 per person. Under my system, gift givers would never pay a tax. Instead, the person who receives the gift would include it as income. However, I would allow a small amount to be excluded (not $12,000, but maybe a few thousand), because from a practical standpoint, I don't think it would be worth it track all the small gifts that are received and record them as income (and people aren't likely to report small gifts anyway).

Under this system, income and gains couldn't be deferred (or excluded) forever, and there would be no exemption amount. It is very likely that this system would generate more tax revenue than the current system (which only provides about 1% of total tax revenues, despite all the spirited debates on the issue), which has a large exemption amount and a punishing tax rate (even after being decreased to 45%) that encourages people to waste a large amount of money hiring expensive estate lawyers to take advantage of a tremendous number of loopholes to avoid the tax. The current system is just another ill-advised system designed to punish people for committing the sin of being financially successful and having the gall to want to share some of that success with the people they care about (how evil!).

#5 - The taxes on Social Security and Medicare would be eliminated.
Social Security and Medicare taxes would be completely eliminated, which means that employees with earned income of less than $97,500 (for 2007) would see their marginal tax rates drop by 7.65%. The marginal rate drop would be 1.45% for those earning above this amount since the Social Security tax of 6.2% only applies to the first $97,500 of earnings, but they would also save an additional $6,045 of Social Security tax. Small business owners (who have to pay the employee *and* employer portions of this tax) would see their marginal rates drop by close to 15.3% (not exactly, since the employer portion is currently deductible for income tax purposes. This income tax deduction offsets the cost of the payroll tax slightly). Employers would see their cost of labor drop by almost 7.65% for employees earning less than $97,500 and 1.45% for those earning more. Obviously, low-income workers would benefit dramatically from this. Not only would their after-tax income increase by the 7.65% drop in tax rates, employers would be willing to pay more and to hire more people.

Since Social Security and Medicare taxes would be eliminated, Social Security and Medicare benefits would have to be paid out of general revenues. Obviously, this would mean that the flat income tax rate would have to be pretty high to pay for the benefits under the current system. However, I would change the Social Security and Medicare systems so that benefits are only paid to the poor. I know it is a radical concept to pay benefits only to those who need them, but it is a crazy idea that just might work! Out of fairness, benefits would be paid based on the taxes that have already been paid into the system (even though Congress squandered the money on other things long ago).

*************************************************

There it is. That's my proposal. I don't know what tax rate would be required, but considering that most flat tax proposals are in the 17%-22% range, I think the rate for my system could be much lower because of the much broader tax base.

I am under no delusions that such a system would ever have a chance of being implemented, because I know that it wouldn't for a number of reasons (the biggest of which might be that a tax rate of less than 17% wouldn't be perceived as sufficient punishment for someone who is financially successful).
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