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An Extremely Simple Tax Proposal

May, 2013

Introduction

The frantic April 15th tax-filing ritual is over, restaurants and businesses are advertising bargains to cash-strapped taxpayers and once again, we wonder, isn’t there a better way?

Everyone claims to want a simpler, fairer and loophole-free tax system, so here’s a solution so simple that, for most taxpayers, return preparation and filing could be completed in less than one minute – that’s it!

Broaden the Tax Base, Lower the Tax Rate

As Emperor of America, charged with the task of making the income tax system simple, straightforward, with no loopholes, here’s my approach.  It terminates tax-driven businesses, including the tax preparation industry (goodbye CPAs, Turbo-tax and scheming tax lawyers) – and all that waste of time and money.

Individuals

Taxpayers receive a large front-loaded exemption along with drastically lower tax rates, in exchange for eliminating all deductions:

  • From $0 to 50,000 = no tax
  • From $50,000 to $100,000 =10%
    Thus, the first $100,000 of income is taxed at no more than 5% ($5,000 maximum)
  • From $100,000 to $250,000= 20%
  • From $250,000 to $500,000 = 25%
  • Over $500,000 = 30%

That’s it, a major reduction in the current tax rates, which range as high as 39.6% for taxable incomes exceeding $400,000 for joint filers.

No Write-Offs

Oh by the way, there are no deductions, exemptions or credits whatsoever. Seriously, no deductions for mortgage interest, charitable donations, state, local, sales or property taxes, alimony, retirement contributions or medical expenses.  The first $50,000 you earn is tax free (you pay only 5% on the first $100,000) and replaces all deductions.  Also, all income is taxed at the new rates, thereby eliminating capital gains (a major cause of complexity and abusive tax planning) and other preferential tax rates; in addition the alternative minimum tax is tossed out (another huge source of mind-boggling complexity and unfairness).

Filing

Since IRS directly receives information concerning wages and compensation, interest, dividends, royalties and other reportable payments, it can compute your taxes instantly.  Consequently, for the vast majority of taxpayers, returns can be prepared and submitted on-line in less than a minute.  With all deductions eliminated, the tax calculation is simple.

For those with business and investment income and expenses, the process is slightly more complicated.

Business and Investment Deductions

Business and investment income is taxed differently because legitimate deductions are incurred in the production of that income.  However, I would eliminate all deductions except for directly-related and essential expenses actually incurred (costs of purchasing raw materials, labor, rent, direct overhead) and not subject to accounting manipulations.

No Interest Deductions

There would be no interest deductions, since they distort our tax system by favoring borrowed funds (debt) over direct investments (equity).  Eliminating the interest deduction should collapse deals whose economic survival depends on writing-off interest expenses, such as leveraged buyouts and leveraged real estate deals, tax shelters and securities speculations.

Limited Depreciation Deductions

There would be no deductions for depreciation on real estate, no oil or gas depletion allowance, no amortization for intellectual property or goodwill; only business assets that actually wear out within seven years will have a depreciation allowance.  Eliminated are deductions for entertainment, meals and perks for execs, such as automobiles and club memberships, although a straight mileage allowance for vehicles actually used in  business would be permitted.

“Tax-free” exchanges of real estate would no longer exist (the transaction would be immediately taxable) and reorganizations (mergers, acquisitions and alike) would be subject to a flat tax of 2% on the gross value of the transaction.

The upshot:  businesses and investments would have to stand on their economic merit, rather than on tax loopholes and accounting shenanigans.

World-Wide Income

Individuals and entities would be taxed on their world-wide income, whether or not the income, whether or not the funds were repatriated to the U.S.  The current gimmicks used by Apple, Google, Marriott and others to escape U.S. taxation by transferring intellectual property to foreign subsidiaries would be stopped.

Entity Tax Rates

Entities will pay 5% tax on the first $100,000 of gross income, then 15% to $5.0 million, then  25% over that amount. Note: the current corporate tax rate is generally 35% on income over $100,000.  Current flow-through entities (partnerships, LLCs and S-corporations) would be taxed as entities.  As with individuals, the reduced rate up to $5.0 million compensates entities for the loss of deductions.

Minimum tax

Individuals with gross receipts of more than $100,000 will pay a minimum tax of 2%. Entities with gross receipts of more than $25 million a will pay a minimum of 4%.   This will eliminate accounting tricks and gimmicks.  These minimums will apply each year, carryover losses will not reduce the minimum tax – every individual and entity will pay at least the minimum tax – no exceptions.

Example:  An individual earns $1.0 million in real estate income, but claims $1.2 million in deductions. Even so, the individual pays 2% on the million or $20,000 at a minimum.

Example:  Assume GE has $150 billion of gross income but currently pays no income taxes.  Under the minimum tax, it pays $6.0 billion.  Thus, GE, even with its army of 375 tax lawyers, will not escape the minimum tax.

Audit Risk

If an entity is caught under-reporting taxes by more than 10%, the minimum tax doubles to 8% for the next three years.  This should deter companies that hire boatloads of accountants and attorneys to finagle their taxes.

Conclusion

This drastically simplifies our current tax code by eliminating loopholes and special interest deductions that have created such a mess.  It is simple, fair, and causes every individual and entity to pay taxes.

The reduction of billions of hours of wasted time and dollars spent on dealing with the current law will boost our economy, but the most important result is that businesses and investments will once again base their decisions on economic merit, rather than on gaming the tax system.

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