REAL TAX SIMPLIFICATION

If we were really to have income tax simplification it would be achieved through a principles based approach. I am including an example/recommendation.

First principle: Fairness is achieved when 99% of the population with an IQ greater than 85 can complete the individual income tax form and get the same result as a professional preparer.

Second principle: No tax collection system is beyond manipulation. For example tax based on income, and tax based on sales has a different distribution of taxpayers, even though the total tax collected is equal. Balancing four basic systems (income, value added, property, and estate taxes) achieves a more equitable distribution among tax payers, no matter what they choose to do. 

Third principle: Eliminate choice or discretion. Some people always make the wrong choice, and pay more. Some always make the right choices and pay less. And most people are somewhere in between, depending on the time they commit to understanding the affect of their choice. There is no real reason for it other than to allow government to manipulate the citizen in ways they want the citizen to go. However, the cost of this system is 100’s of billions of dollars that can be saved every year.

Fourth principle: As the precision used in defining tax law increases, the amount of law and regulation to support it goes up logarithmically and the common understanding of the population drops faster. For example, if income (defined for tax purposes) was defined as the cash benefit you received. This is adequately described in a few paragraphs and intuitively understood by virtually all adults. Whereas, the present code takes volumes of books and court cases to inadequately describe it, and consequently is not understood by 99% of the population.

So how would the income tax system be simplified with those principles in mind?

1. Eliminate the filing status. (Married filing joint, single, married filing separate, and head of household would be eliminated)
2. Eliminate Alternative minimum tax.
3. Eliminate Passive income rules.
4. Eliminate excluded income from taxation.
5. Eliminate separate tax rates for specialized income, such as dividend and capital gain.
6. Eliminate phase in and out of tax changes over several years. Make the change once, and make it permanent.
7. Allow interest and dividend income on schedule B to be offset by personal interest expense on schedule B, but not below zero.
8. For all sales of property: Allow for unlimited deduction of loss to the extent of taxable income. For gain property, compute the basis (increase basis/reduce gain) using the CPI index schedule published by the IRS, but not to create a loss.
9. Eliminate itemized deductions and other adjustments to taxable income that are largely personal expenses, and not business expenses. Instead calculate an acceptable amount for most people. I say that is $15,000 and give it to everyone as a standard deduction. (Note a married couple would get a total of $30,000, which exceeds 98% of all itemized deductions taken currently.) This would eliminate the filing requirement for most of the population and make the tax system primarily a system of redistribution of wealth.
10. Eliminate credits.
11. All business and other entities (sole proprietorships, rental of real estate, corporations, LLC, charities, non-profits, trade associations, trusts, and any other non human entity) will report their income and expenses on a common corporate return, on September 30th each year, and pay the corporate tax rate. However, there would be elections to flow through income to 50% or more owners (Form K-1), and/or deductions for distributions (dividends) made to owners who report and pay tax on such income. 

The above simple simplification will save $500,000,000,000 in tax preparation cost and administration, not reduce the income to the government, and creates fairness amongst taxpayers. It would also integrate with a value added, or national sales tax system to collect appropriate amounts of tax.

1 One of the most inefficient processes in the world is the tax preparation industry. Buildings and people are compensated in 2.5 months for a year’s wage. Spreading the process to 7 months would create huge efficiency gains for government and the industry.

2 Please note that this is not an unconsidered recommendation. For example, charitable organizations would pay tax if their income was greater than expenses for charitable work. However, treating contributions from donors as capital contributions would result in most active charities paying no tax. NOL’s carryback will cure virtually all timing problems. And charities that were not actively supported and not actively engaged in charitable work would be paying tax, a self regulating device. The same would be true for other non-profit entities.

3 Most of the tax code addresses the timing and character of income. This suggestion greatly reduces the problem of characterization. The timing of income is controlled effectively by existing rules effecting Corporations. By reporting all income on corporate returns we take the entire issue away from the personal income tax reporting and control timing on an entity by entity basis. Said simply, if you get the cash you report the income. People understand that and are inclined to voluntarily pay a tax that is intuitively fair.