Flat income tax proposals are back in the news again with Herman Cain’s 9-9-9 plan to Rick Perry’s soon to be announced flat tax plan. While flat tax proposals are often portrayed by the media as being provincial to Republicans – it is worth noting that both former House Democratic Leader Dick Gephart and California Governor Jerry Brown when he was a Presidential candidate proposed flat taxes.Flat taxes are often promoted for their simplicity – that the tax code is too complex, riddled with exemptions and this will make it easy. It has also been suggested that mutiple tax rates make the code complex. The reality is the income tax is complex even with there were no deductions such as mortgage interest, state taxes etc. It is complicated because determining what is and what is not taxable income requires rules and one rate or 10 rates, this will not change.
The hard part of the income tax is determining taxable income. Once you get that number Turbo Tax or any number of software programs will calculate the tax for you. Even before computers, most people looked up their tax in a tax table matrix based on their taxable income and number of dependents. Even for the upper income whose incomes exceeded those on the tax tables, the calculation on the actual tax was third grade mathematics.
Are gifts taxable? Does it matter if it cash or non-cash? What about insurance settlements? There are insurance settlements that are taxable, others that are not. What about instalment sales? How without rules would someone know they need to report all or only part of their gain on an instalment sales in a given year? Certain employer perks such as company provided cars carry tax ramifications, other like employer paid health insurance do not. Maybe they should both be treated the same, maybe not – but you need rules – a tax code for anyone to know what to do. The bottom line is any income tax is complicated because everyone left to own devices would not agree on what is income.
Bond investors are often faced with complicated tax situations because the IRS has determined that phantom interest whether in PIK form or OID is taxable. Would it not be easier to simplify the tax code by only taxing cash interest payments as opposed to “accreted value” ? How does a flat tax solve for this complexity?
That flat tax proposals are so popular is an indication that people do not have the attention span to deal with the granularity necessary in administering an income tax. This is not to say we cannot simplify the code, we can – but a flat tax will simplify nothing.
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