With Tax Day upon us, it’s time to reflect and create a better tax system. The one we have now—the Internal Revenue Code—is a complicated failure that hinders America’s growth while allowing the politically well-connected to get special breaks that are not available to average workers and businesses. This corrupt mess should be ripped up and replaced by a simple and fair flat tax.
The major features of a flat tax are:
- A Single Flat Rate. Instead of tax rates that punish people for contributing more prosperity, the flat tax has one low tax rate for everyone. This minimizes the tax penalty against productive behavior, such as work, risk taking, and entrepreneurship.
- Elimination of Special Preferences. The flat tax would get rid of provisions in the tax code that give special treatment to certain behaviors and activities. Getting rid of deductions, credits, exemptions, and other loopholes will significantly reduce corruption in Washington.
- No Double Taxation of Saving and Investment. The flat tax would eliminate the tax code’s bias by ending the double taxation of income that is saved and invested. This means no death tax, no capital gains tax, no double taxation of saving, and no double tax on dividends.
- Family-Friendly. The flat tax does have a “loophole.” Households receive a generous exemption based on family size. This protects the poor from being taxed. And there’s no marriage penalty, unlike the current system.
The flat tax means radical simplification. Instead of the hundreds of forms needed to enforce the current system, a flat tax requires just two postcard-sized forms. Labor income is taxed on the household postcard and capital income is taxed on the business postcard. For households, each family would report wage, salary, and pension income on Line 1, which should be easily available from W-2 forms. Using Lines 2–5, the household then would calculate its personal allowance, which is based on family size. The personal allowance is then subtracted from income to determine taxable income, which is reported on Line 6. The amount of tax is calculated on Line 7. This amount is then compared to the amount of tax withheld on Line 8, which then leaves either a tax payment (Line 9) or a refund (Line 10).
This postcard is so simple that a third-grader could file a family’s tax return in about five minutes – in part because families do not need to worry about reporting dividends, interest, and other forms of capital or business income. Those forms of income are taxed using the business postcard, which is equally simple and transparent. Total revenues go on Line 1. Businesses would then add together their wage costs, their input costs, and their investment costs on Lines 2 and 3. These costs are subtracted from gross receipts to determine taxable income on Line 4. Line 5 is the amount of tax that is due. Lines 6–10 only exist in case a company has losses to “carry forward” from one year to another.