Before I get started I want to say one thing: when I write about taxes I reserve the right to change my mind, just as I do when I write about other topics. Okay.
I’m in the middle of a little self-education campaign re. America’s tax system. The reason I’m doing it is that it occurred to me that while I’ve always complained about paying taxes, I’ve never really understood them. I mean when I entered the work force I had no idea what Social Security, Medicare/Medicaid or FICA was. I just knew there was a chunk of change being pulled out of every paycheck to be held by the government for when I was an old geezer, and what 16-25 year old cares about that?
Then a few years ago I started reading that Social Security probably wouldn’t be there when I retired, or that the government was dipping into social security to pay for stuff. My little English-Lit brain kind of went, "Huh?" and then moved on because I had things like kids and work to worry about.
Now, though, I want to take the time to understand. I want to know what income taxes are, why we have them and why our tax system is so complicated. So I went on-line and bought a bunch of used books and I also went to the library to check out one book in particular, David Cay Johnston’s "Perfectly Legal." It’s been a real eye opening experience.
Side note: I don’t agree with some of Johnston’s recommendations but I
found a lot of his background information fascinating and some of his
arguments compelling. Definitely a worthwhile read, as is his coverage
of the IRS for the New York Times.
I still consider myself on the front end of the learning curve on income taxes, but after reading Perfectly Legal and starting in on a history of taxes in America (Federal Taxation in America: A Short History, by W. Elliott Brownlee) I can say that I think the following:
- Income taxes are absolutely necessary. While we can all argue about how much we should pay in taxes and about how much government we should fund (i.e. what the government should do with the money) I think we can all agree that part of being in our society is contributing to the common well-being of the nation and income taxes are an effective means to that end.
- Income taxes can be fair, but currently aren’t. I’ve read a lot of arguments for flat taxes and federal sales taxes, but I have to say that if the income tax system is fixed properly I think it has the most potential to be the most equitable.
- Republicans and Democrats are both responsible for the current state of the income tax system.
- Our income tax system is unnecessarily complex, and that complexity hurts the middle class most and helps the upper class most.
- The system is complex because the various loopholes and incentives that create the complexity benefit Congress’ most influential constituency, what Johnston calls the political-donor class.
- The reason that the middle class is hurt the most by this system is that most people within the middle class have what I’d call normal income; wages and salaries. They also have a higher share of their income taxed for Social Security. The wealthy, especially the extremely wealthy, get most of their income via interest on their equities, stock options, etc. Also, the average middle class person is taxed before they get their money while the wealthy are taxed after they’ve had their money in their pockets for a while.
- The debate about taxes needs to start with a debate about defining income. We need to define income before we can get serious about tax reform.
- We also need to debate the goals of the country, the fiscal priorities of the country, while we debate tax reform. We may discover that we can reduce all of our taxes if we get serious about cutting back on what we expect the government to do.
- The average American is woefully ignorant of the tax system, how it works and its history. I’m willing to bet that the vast majority of Americans don’t know that income taxes didn’t exist until 1913 or that the top income tax rate during WWII was 90%. Puts the current top tax rate in a different perspective doesn’t it?
- Finally, there is no one in power that has an interest that would be served by fixing the system. I wouldn’t count on anyone in power today to fix this thing. It will have to be a remarkable grassroots effort.
Here’s the biggest thing I’m struggling with: should the wealthy pay a higher percentage of their income in taxes? The rationale for this "progressive" taxation is that the wealthiest have accrued the greatest gains from our society and thus should pay a requisite share. On the other hand if I make $100,000 and you make $1,000,000 and we both pay 20% then I’m paying $20,000 and you’re paying $200,000. It looks to me like you’re already paying more.
Of course the reality is that in today’s system my $100,000 is actually less because I’ve had Social Security taken out of a huge chunk of it. In fact you paid the same amount of Social Security on your one million as I did on my 100k, so right there I’m playing catch up. And you’re much more likely to have loopholes to exploit and to have paid a tax lawyer to find them for you. So in today’s system maybe we need you to pay 35% to make it equitable.
But if we redefine income to include all money we gain in the year no matter how we gain it, and do away with the loopholes and then come up with a tax rate that will serve the country’s needs, do we need to have a progressive tax? One point here is that we’d probably want to have a lower rate (or no tax) for the truly poor, but above that line we might be able to have one fair rate.
I’ve also read the argument that if we went this route we’d kill the incentives for investing in public companies, which is a key driver of economic growth. I don’t know if I buy that though, since you’re still basically making money for doing nothing other than gambling on a company’s success, and that’s pretty easy money. Can’t see the possibility of paying income taxes on easy money reducing its allure. (I’m thinking that Greensboro blogger David Boyd might be prepared to debate/educate me on this point).
But, here we come to another sticking point for me: how do we tax someone who hasn’t realized the gain yet? In other words if I’ve invested in Microsoft and the company gains 10% on the year, should I get taxed on the capital gains now or should I get taxed when I actually sell the stock and get the cold, hard cash? I guess I could pay the capital gains now and then if I lose money the next year claim a deduction, but then we start getting back into complexity don’t we?
So like I said, I’m on the front end of this process and I have a long way to go, and I’m sure my thoughts will evolve on these matters. But one thing I’m pretty certain will not change is my feeling that the system is broken, it’s not fair and we need to fix it for the good of our country.