United States Tax System

United States Tax System The United States tax system is in complete disarray. Republicans and Democrats agree that the current tax code is complex, unfair, and costly. The income tax system is so complex; the IRS publishes 480 tax forms and 280 forms to explain the 480 forms (Armey 1). The main reason the tax system is so complex is because of the special preferences such as deductions and tax credits. Complexity in the current tax system forces Americans to spend 5.4 billion hours complying with the tax code, which is more time than it takes to manufacture every car, truck and van produced in the United States (Armey 1).

Time is not the only thing that is lost with the current tax system; Americans also lose great deal of money complying with the tax code. Resources that are currently wasted on record keeping, filing forms, learning the tax code, litigation, and tax avoidance. The cost of complying with the current tax code totals about $200 billion annually, or $700 for every man, woman, and child in America (Armey 1). The overwhelming consensus that the current tax system is inadequate has ignited the search for tax reform. There are numerous proposals for tax reform; one particular proposal brought forth by various conservatives is the idea of national flat rate income tax. The idea is to replace the current income tax with a single rate that everyone pays.

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This paper will take a close look at the concepts of the “flat tax,” and look at the possible benefits and potential failings. Although there is a basic format to the flat tax, there are multiple flat tax proposals that have been offered by conservatives. Along with critiquing the basic format of the flat tax, this paper will compare and contrast the different flat tax proposals. There is no doubt among Americans and politicians that there is need for tax reform, the flat tax and one of its proposals could possibly be the answer to tax reform. The American people are in the presence of the highest tax burden in American history; taxes represent a larger share of the U.S. economy than ever before (Armey 2).

After World War II, the average family sent only about three percent of its income to Washington. The same family today gives 24 percent of its income to the federal tax collector (Mitchell 1, 9). Once state and local taxes are added to the federal take, taxes make up the biggest slice of the average familys budget. As Daniel Mitchell of the Heritage Foundation shows in Figure 1, the typical American family now pays more of its budget in taxes than it spends on food, clothing, transportation and shelter combined (Mitchell 1, 10). Policy makers have introduced a solution to the staggering proportion of taxes that Americans spend.

The flat tax, based on an idea developed by Professors Robert Hall and Alvin Rabushka of Stanford University to create a fair, simple, and pro-growth tax system (Mitchell 1, 11). There are four basic criteria that make up a flat tax. First is a single low rate on taxable income, the baseline for taxable income would be raised to a certain amount dictated by a personal exemption. Second is simplicity, all Americans would fill out the same postcard-sized form to pay their taxes. Third is the reduction or elimination of deductions, credits, and exemptions, depending on the different proposals. Last is the elimination of double taxation, the government will no longer be able to tax income saved or invested (Mitchell 1, 11). These four pillars of the flat tax make the proposed plan very appealing to many Americans, each proposal uses these pillars to try and create the most efficient flat tax.

The Armey/Shelby flat tax, based on the Hall/Rabushka flat tax would replace the current personal and corporate income tax with a simple 17 percent tax on all income. With the exception of a generous family allowance ($33,300 for a family of four), all labor income is taxed at the individual level. Taxes on business income (such as interest, dividends, capital gains, and rent) are withheld and paid at the business level. Both businesses and individuals would fill out simple post card sized returns (Mitchell 3, 3). Using the same model as the Armey/Shelby flat tax, Senator Arlen Specter, purposes a slightly higher rate of 20 percent and lower personal allowance in order to maintain limited deductions for charitable contributions and the full deduction for home mortgage interest (Mitchell 2, 3). Steve Forbes proposal is much the same as the Armey/Shelby proposal.

Forbes uses the same 17 percent as the Armey/Shelby plan, but increases the family of four allowance to $36,000 (Mitchell 3, 3). Senator Phil Gramm and Pat Buchanan both setup their respective proposals quite different from the others. Gramm uses a 16 percent rate, however keeps deductions for home mortgage interest and charitable deductions, but the biggest difference is the continued double taxation of many forms of income. Capital gains taxes would not be abolished, while income used for savings would continue to be taxed twice and the bias against business investment would be reduced, but would not be eliminated (Mitchell 3, 3). Buchanan follows Gramms format but uses a low 15 percent rate.

Corporate profits would continue to be taxed at both the individual level and the business level. Savings would be taxed twice. There would be a flat 17 percent rate on corporations, but provisions biasing the current system against investment, such as the alternative minimum tax and depreciation, would remain (Mitchell 3, 3). All of these competing flat tax proposals are possible plans for tax reform. However, because only the Armey/Shelby has spent a generous amount of time in the public eye there is limited discussion on the other proposals. For the purpose of a fair analysis of the flat tax this paper will focus on the basic structure of the flat tax as created by Robert Hall and Alvin Rabushka. Proponents and critics of the flat tax agree on at least one aspect of the flat tax, simplicity.

The flat tax replaces the endless exemptions and loopholes with a postcard-size form that all Americans would fill out whether they are a CEO or young kid flipping burgers. The Tax Foundation estimates that a flat tax would reduce compliance costs by 94 percent, freeing up resources that are currently wasted on record keeping, filing forms, learning the tax code, litigation, and tax avoidance, saving taxpayers more than $100 billion in compliance costs each year (Armey 3). One of the major areas that proponents of the flat tax claim fame to is the issue of fairness. They argue that no matter how much money a person makes or what they do, they will be taxed the same as every other citizen. With the elimination of deductions there are no loopholes to help the wealthy get out of paying taxes.

Critics argue that by eliminating taxes on capital income the gap between rich and poor will become even bigger. By eliminating the current tax on savings and investment not only will future taxes on savings be avoid, but so will existing savings and investments. This would represent a huge tax windfall to current investors, most of who are in the top five percent of the income distribution (Hamond 1). Families with the same total income will face vastly different tax burdens …