If I Ran the Zoo

          “It’s a pretty good zoo,” said young Gerald McGrew,
“And the fellow who runs it seems proud of it, too.”
“But if I ran the zoo,” said young Gerald McGrew,
“I’d make a few changes, that’s just what I’d do…”

          Dr. Seuss, If I Ran the Zoo 


A complete overhaul of the federal tax system would be a good candidate for the next big legislative priority.  Every year in recent memory has had a nail-biter, wondering if Congress would manage to execute all the necessary fixes in time.  The long list includes AMT fixes, Marriage Penalty fixes, rate fixes, expiring provision fixes, to name a few.  If you had a car that needed so many fixes, you would want to replace it, instead of spending the additional time and money on what is obviously a clunker.

Now I realize that like young Gerald McGrew, I am engaging in a flight of fancy.  But I do think it would be a better zoo.

The current Social Security and Medicare taxes would be eliminated and the programs funded through the revised income tax.  Capital Gains would be taxed as ordinary income except that assets held for more than a year can be adjusted for inflation over the holding period.  The rate used for adjusting for inflation will be the long term Treasury bond interest rate, not the CPI.

Deductions would be redefined as expenses: to mean only expenditures solely and uniquely necessary to earn the income reported on the tax return.  The standard deduction would therefore be eliminated.  Exemptions would be completely eliminated.

I understand that legislators would feel a need to continue rewarding some activities.  All former deductions and exemptions that would be continued (hopefully a very short list of the ones with real benefits!) would be converted into credits.  Most credits would be nonrefundable but all will start at the first dollar and be capped at some maximum.  For example, the current deduction for charitable giving would be converted to a ten percent credit for charitable donations, up to a maximum of ten percent of net income.  The stated purpose of the current deduction is to reward charity, but it (i) only rewards the charity of people who itemize and (ii) gives a bigger reward to those in higher tax brackets.  Similarly, the current mortgage interest deduction, if it needs to continue at all, would be replaced with a credit of up to ten percent of the first twenty thousand dollars of home payments on an owner-occupied dwelling.  The stated purpose of the mortgage interest deduction was to encourage people to buy homes and establish roots in the community.  But most of the money went to owners of the largest and most expensive homes, encouraging people to overbuy. Finally to introduce a level of progressivity into the system there would be a fixed standard credit for every citizen or legal resident either to be taken themselves, together as a couple, or by the person claiming them as a dependant.

The estate tax and gift tax will also be changed.  To the extent that an inheritance contained unrecognized capital gains (appreciated stocks or assets, etc.) they would be taxed as if the decedent had sold them at the time of death or that the giver had sold them at the time of the gift.  If the inheritance or gift is an ongoing business such as a family business or farm that is going to be actively and personally managed by the inheritor, then the tax can be postponed indefinitely until the business or its assets are sold.

Corporate Net Income would be taxed at the same rate as personal income.  To address double taxation issues, corporations get two credits.  First is a percentage credit on dividends paid to persons paying US income tax.  Institutional investors would count towards the credit to the extent that they can certify the percentage of the fund holders or beneficiaries that are paying US income tax.  The second is a credit for ten percent of wages paid to employees who are subject to US tax (unless those wages were already deducted as part of net income calculation).

You certainly are wondering what are the tax rates?  First, there is only one rate.  Before being shocked at the lack of a progressive tax table, remember that (i) this proposal eliminates payroll taxes, which are regressive, and (ii) a considerable degree of progressivity is built into the credit system.  When looking at both income and payroll taxes, the taxes on the first several thousand dollars will be lower.

But the more surprising thing about what the tax rate would be is I don’t know.  Each year as part of the budget, Congress would set revenue targets for the income tax to go toward the Social Security, Medicare, and general fund.  The treasury department will then use prior year data and reasonable growth projections to calculate the necessary rate to reach those targets and set the tax rate for the next year.  This means that when Congress is setting the budget they won’t be able to hand-wave about projections of how much it will increase the deficit.  Instead, they will be declaring it, right in the budget.  Moreover, when Congress decides to get generous with some new idea, it won’t fall unnoticed and forgotten into the deficit.  It instead will directly increase the tax rate.

I realize this glosses over many details.  Just covering all of the things that constitute income would take far more than this posting.  And, I am certain that there will still be efforts to circumvent the system.  But when something is simpler, it is also harder to find a place to hide.

“Yes Indeed!” said young Gerald McGrew.  “Things would be different if I ran the zoo!”

Permanent link to this article: http://betweenthenumbers.net/2011/01/if-i-ran-the-zoo/


3 pings

    • The Tourist on January 14, 2011 at 12:28 PM
    • Reply

    Can I clone your article to my blog? Thank you…

    • rolex watches on October 12, 2011 at 3:48 AM
    • Reply

    Quite right! It is excellent idea. I support you.

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