Disproportionate Taxes
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Since the beginning of time, there has always been a debate regarding the best way to tax a people. In the United States, conservatives tend to favor a "flat" tax in which rich and poor are taxed at similar percentages while liberals often favor a "progressive" tax in which more wealthy individuals pay a higher percentage than less wealth citizens.
We wish to examine the underlying motivations, morality, and practical truths and make sense out of the different points of view while - hopefully - coming to some conclusion as to what sort of plan makes the most sense.
Flat Taxes
A flat tax is generally accepted to mean that a person gives a fixed percentage of his/her income to the government regardless of the income level. At a 10% tax rate in this system, a person making $1.00 would pay a $0.10 tax while a person making $100,000.00 would pay $10,000.00 in taxes. This, of course, assumes that the taxes are based on income.
There are other types of tax bases, such as sales tax, which will create "taxable events". Many states - such as Virginia - implement a flat sales tax in which all goods are taxed at the same rate. This is also a form of flat tax, but - to be clear - we are not referring to sales taxes throughout this essay.
Another notable flat tax is the US capitol gains tax, which is a flat 15%. As most wealthy individuals tend to draw their taxes from capitol gains, this tax is often the tax that applies to the wealthy in the US.
Motivations
Potential advantages of a flat tax:
- simplicity - easiery for tax payer and tax collector reducing accounting/legal fees
- the return on making a dollar is always the same
- the appearance of 'fairness', although fairness is always an illusion
Potential disadvantages of a flat tax:
- poor pay higher tax percentage after their necessities are paid for
- historically unproven or poorly represented
Practical Considerations
A flat tax would likely eliminate large portions of the tax industry (pro or con?) that rely on the complexity of the US tax code for employment. This would mean a modest cost savings for the government, but more significant tax savings for corporations and individuals as the taxes for a particular year would be easily calculated on a piece of paper.
The flat tax does give the appearance of fairness, but likely is not a true representation of fairness from the day-to-day interactions that less wealthy individuals have with the government. For instance, a person who makes $50,000 would likely pay 15% to 25% of their income for housing while a person making $1,000,000 would likely pay a much smaller percentage of their income for housing, even for a more expensive house. Once the individuals' needs are met, the less wealthy individual likely pays a much higher percentage of their discretionary budget on taxes than a more wealthy person.
Finally, there are a few instances of countries which have implemented flat taxes and there have been no obvious successes. It remains to be seen whether this is a result of the flat tax system or, rather, the specific implementations of it. Simply put, there is not enough data to support the idea that a flat tax is even a good idea.
Progressive Taxes
Progressive taxes generally require that less wealthy individuals pay a smaller percentage of their income as taxes than wealthy individuals. In the US federal tax code, this system is tiered. Each income bracket gets taxed at a different rate. For instance, the first $9276 is taxed at 10%, but all income between $9277 and $37615 is taxed at 15%.
Motivations
It is often the case that proponents of progressive taxes are attempting to make it easier for the less wealthy to rise in wealth. As an individual's wealth and assets rise, so does the tax rate. This tend to be something of a populist proposition for obvious reasons.
Practical Considerations
The primary consideration of a progressive tax is that wealthy individuals tend to pay a much higher percentage of their income than lower-income individuals. Every extra dollar that a person earns is taxed at a slightly higher rate, reducing the incentive of earning more money.
Tax Reductions/Exemptions/Credits
US tax systems - state and federal - tend to use "deductions", which allow an individual to subtract certain items to be exempt from taxes. A single person can opt to take the standard deduction of $6300. This has the effect of making a 0% tax bracket up to the standard deduction.
A tax credit is a direct credit to an individual's bill to the IRS. For instance, if a $3000 tax credit is offered to a person if he installs solar panels on his home, then the IRS will treat that person's tax bill as if he had already payed $3000 of it. This is also known in many circles as spending through the tax code.
There are instances in which a very large portion of an individual's income may be deducted and politicians will often attempt to influence social or economic behaviors through deductions and credits, complicating the tax code. This topic is for another day, but it is worth mentioning that a "progressive" tax implementation often does not actually tax more wealthy individuals at a higher rate.
W-2 Income vs. Dividend Income
Most investors try to make their portfolio consist of 'qualified' dividend income, which is taxed at a lower rate than regular income. Non-qualified income is taxed at the same rate as qualified income. Qualified income is bracketed, but the tax brackets are lower. The maximum tax rate of qualified income is 20%. If Jim makes $1,000,000 in W-2 income, he is taxed at an effective rate of 30%. If his friend Bob makes the same income in the form of dividends, he is taxed at an effective 17%... nearly half the rate! Fair? This doesn't even take into account that Jim was likely putting in 50 hours a week while Bob could have just as easily been binge-watching the latest Netflix release.
Conclusions
In the end, it is this author's belief that a progressive tax system with no deductions, credits, or exceptions would best serve the country. All income - regardless of source - should be treated as income and taxed at the appropriate rate. This keeps tax burdens reasonable for all individuals and doesn't create special cases for special classes.
More Information:
Category: taxes.