Reforming the tax code: A start to fiscal recovery

Our country needs to have a serious conversation about restoring fiscal discipline. For that to happen, both sides must leave their talking points at the door — Republicans need to place their oath of office above their pledges to never raise taxes, and Democrats need to be willing to consider proposals that do not disproportionately thump the richest of Americans.

Despite what you may have heard, taxes are not spiraling out of control. Quite the opposite. Last year, federal tax receipts fell to their lowest levels since 1950, now just 14.9 percent of GDP compared to the post-World War II “average of 18 to 19 percent”:http://economix.blogs.nytimes.com/2011/05/31/are-taxes-in-the-u-s-high-or-low/. This may not seem like a big drop, but the difference amounts to approximately $560 billion — enough to cut deficits in half or fund annual Social Security and Medicare shortfalls in perpetuity.

There are a few reasons for the drop. Some are structural and beyond immediate control, like the collapse of tax revenue when the economy slipped into recession. Others are the result of short-sighted public policy — namely, the Democrats’ extension of the Bush tax cuts and their gradual chipping away at payroll tax rates.

Coupled with a decrease in tax revenue, the spike in federal spending — both as a result of automatic stabilizers and discretionary attempts at stimulus — has resulted in some of the largest deficits in years. And while I don’t buy into the doomsday predictions of those who think soaring levels of debt will push America to the brink of insolvency, as it has with Greece and Portugal, there is no doubt that the path we are on is unsustainable.

A sensible path forward will require a combination of spending cuts and tax increases. If you believe either could succeed in isolation, well, I’ve got some mortgage-backed securities you might want to buy.

In all seriousness, the first step should be to revamp our broken tax code. Currently, a dollar made from labor is taxed at a much higher rate than a dollar made from investment, thanks to the egregious carried-interest loophole that allows billionaire investors like Warren Buffett — and 26.5 percent of households making more than $1 million a year — to get away with paying lower tax rates than secretaries, teachers and police officers.

Progressive taxation is also undermined by payroll taxes. Because the portion of taxable income is capped at $106,800, payroll taxes are actually regressive: The rich pay a much smaller share of their overall income in payroll taxes than those in lower income brackets.

The last major problem with our tax code is that corporate lobbyists have been able to carve out a whole host of loopholes, allowing the companies they represent to pay little to nothing in taxes. Care for a few examples? In 2008, Goldman Sachs paid only 1.1 percent of its income in taxes, even though “it earned a profit of $2.3 billion”:http://sanders.senate.gov/newsroom/news/?id=67562604-8280-4d56-8af4-a27f59d70de5. The following year, Chevron received a $19 million refund from the Internal Revenue Service despite profits exceeding $10 billion. And last year Bank of America received a $1.9 billion tax refund despite taking home $4.4 billion in profits.

I’m more than happy to see American companies make tons of money — that’s one of the great things about capitalism. But if companies want the rights of personhood, when it comes to protections under the law, then they should bear the responsibilities of personhood as well. Why should corporations be exempt from paying the same level of taxes as the rest of us?

So, what to do?

Instead of distinguishing between different income types — income from labor, income from capital gains and corporate income — I would treat them all equally. All realized income above approximately $50,000 (the exact number should depend on relative costs of living) should be taxed at the flat rate of 25 percent, without exceptions or deductions. This means that Warren Buffett would pay the same rate on the last dollar of his considerable income as I would pay on the first dollar of mine above $50,000.

I can’t see how things could be much fairer than this.

To put these numbers into perspective, a middle-class family making $75,000 a year would be responsible for paying $6,250 in taxes — about 8.3 percent of their total income. After the loopholes have been removed, wealthy individuals would end up paying no more than 25 percent of their total income in federal taxes, a much lower rate than is seen in any other developed country with the exceptions of “Andorra, Monaco and Switzerland”:http://en.wikipedia.org/wiki/Tax_rates_around_the_world.

The benefits of this new tax code cannot be overstated. It would be simple without being simplistic, progressive without being unfair. Not only would it save millions of man-hours spent filling out complicated tax forms and reduce the labor need for IRS agents, this plan would increase revenues back to approximately 19 percent of GDP — the upper end of historical averages — once exempted income is taken into account.

By itself, adjusting the tax code so that it is more progressive — and less susceptible to lobbyist-driven loopholes — will not eliminate soaring budget deficits. But it will provide a strong foundation for reviving the middle class, kick-starting demand and restoring our economy’s footing so that it will once again be the envy of the world.

_Jason is a senior in Engineering and Business._