It has been more than 41 years since I practiced tax law, but I would nevertheless like to put forward an idea relating to the income tax system. Conceivably it is a good idea. Conceivably it is a bad one. It needs analysis by experts who are deeply familiar with the tax system. The tax lawyers, accounting firms, Washington lobbyists, Congressmen and others who make their living creating and manipulating the fantastically complex, incredibly-abused-by-the-rich and quite possibly immoral income tax system we have today will likely be against it. For it would simplify the tax system immensely, and these tax players would be out of business or would lose power. Their opposition will therefore be automatic, and should automatically be discounted. The question will be, what are the views of more independent economists, lawyers, and accountants who do not make huge fortunes or wield enormous power due to the current tax system?
The idea in mind is this: The current income tax should be replaced by a gross receipts tax (which could also, if you wish, be called a gross income tax, no pun intended). The current income tax is based not on gross receipts (or gross income) but on net income, i.e., on gross income minus numerous deductions. That is true for both businesses and individuals. It is in the Congressional creation and the private use of deductions (and subsequent credits too) that much our present chicanery arises. Much of that chicanery would be ended if there were no deductions (or credits) (1) that are created for (generally wealthy) private interests by a Congress which, acting at the behest of an army of highly-paid lobbyists, is, for practical purposes bribed (although the bribes are called campaign contributions), and (2) that are manipulated by additional armies of high priced tax lawyers and tax accountants, who figure out how large corporations and rich individuals can pay next to nothing in taxes while the rest of us pay through the nose. In other words, the key to getting rid of much of the chicanery and corruption which is rampant in connection with the income tax is to get rid of the deductions (and credits) which give rise to this chicanery and corruption. This would leave us with a gross receipts (or gross income) tax.
I note that the idea of getting rid of deductions (and credits) is so different from what is done today that tax experts sometimes find this simple notion literally impossible to understand. Sometimes their minds literally cannot fathom the notion because they have been trained for decades to think of taxable income as net income (i.e., income after permissible deductions), not as gross income (or gross receipts), which is income before deductions. Yet there are forms of taxation which, as I understand it (am I incorrect?) are based on gross intake. A sales tax is based on the gross price received by the seller, not the gross price minus the seller’s costs, isn’t it? An import tariff is based on gross value, not gross value minus costs of production and sales, isn’t it?
If an income tax were based on gross receipts (gross income), the tax rate or rates would obviously have to be much lower than currently. The rate could not be, for example, 30 or 35 percent, as it can be (and often is) today when the tax is calculated on net income. Economists with computers would have to calculate the rates that would be needed for the government to operate. Would a single rate of ten percent or 12 percent for all individual taxpayers be enough? For corporations? I don’t know. But the experts can figure it out fairly easily, I imagine.
Should there be only one flat rate for all, or should rates vary with gross income, so that the tax is progressive? Again, I don’t know. The answer obviously depends on one’s social views. Either way, however, the income tax system will be enormously simplified if it is sans deductions (and credits).
How about capital gains? (I am assuming here that they should be taxed -- a point discussed below.) If they are taxed, should they be taxed at different rates than income from wages and salaries? I would think not. They are, in fact, just another form of gross receipts (or gross income) and should be treated that way. This would aid simplification and avoid the distorting and often outrageous efforts to try to convert rich people’s various receipts into lower-taxed capital gains.
One objection sure to be raised to the idea of converting the present income tax system into a gross receipts (or gross income) system is that businesses will have to pay a tax on their gross income (or gross receipts) even if they do not make a profit -- even if they lose money and thus have no net income, but instead have a net loss. Paying a tax when there is a loss is counterintuitive to the current way of thinking about the taxation of businesses. But the answer to the objection is, so what? There are lots of situations in which individuals and businesses pay taxes even though they have a net outgo, not a net inflow, i.e. have a net loss. Individuals who are spending far more than they earn every year must nevertheless pay income tax on their earnings under our current system. Employers have to pay social security taxes regardless of whether they are making or losing money. Import taxes (tariffs) have to be paid regardless of whether the importers are making or losing money.
What would happen is that the ten percent (or 12 percent) (or whatever percent) gross receipts tax (or gross income tax) would be, for businesses, just another cost of doing business. It would be, that is, just another cost that is factored into a determination of whether a business will or will not be profitable, should or should not be started, should or should not be continued. It will be no different in this regard than wages, costs of goods, or, for that matter, the social security tax.
There is also the question of whether certain types of gains should not be considered part of gross receipts (or gross income). This question is intimately tied up with tax deferral. For example, should contributions by an employer and an employee to a pension plan not be considered part of the employee’s gross receipts (or gross income), so that he will not pay taxes on it until years later when he gets his pension? One could go either other way on this, I suppose. Given the importance of saving for the future, one would think current contributions should not be considered part of taxable gross receipts. Also arguing against current taxability of contributions is that payment of tax now would give rise to a form of double taxation when the money is taken out later as taxable pension income. This is a concern as it relates to ordinary persons, though it is not a moral concern as it relates to the system-abusing executives who use one or another kinds of deferral of taxation to amass hundreds of millions, even billions, of dollars.
On the other hand, and arguing for taxability of pension contributions when made, is that one must be careful lest so many kinds of revenues be excluded from gross receipts or gross income that we replicate at that level the current chaos and corruption arising from deductions (and credits). This concern is only the greater because of the vast abuse that filthy rich executives have made of deferral in order to amass hundreds of millions or billions of dollars. To prevent this kind of abuse, pension contributions and related types of deferrals exceeding some stipulated amount should probably be taxed even if sums less than the stipulated amount are not taxed.
There is also the matter of increases in the value of investments which continue to be held (i.e., capital gains), as well as interest or dividends received from investments. Here one would think that interest and dividends, in effect being monies received (even if they are reinvested), should be taxed. Increases in the capital value of an investment due to market or other appreciation -- increases in the value of a stock or a bond -- are not yet monies received, and should not be taxed until the investment is cashed in. For that is when they are actually received.
And how about the original capital which went into an investment? Should it be taxed as a part of gross receipts (or gross income) when the investment is cashed in and invested money is received back? And if it is, should the amount received back be taxed as part of gross receipts even if that amount is less than the original investment, so that the investor had a loss? I don’t know the answers to these questions. Arguing for taxability, however, is that the return of capital is a receipt of money. And, if there were a loss, well, people have to pay sales or import or social security or property taxes even though they have lost money in a business or on property. Also, once again, the more you permit revenue to be excluded from gross receipts (or gross income), the more you are likely to end up replicating our current intellectual and financial corruption even though you have done away with deductions (and credits). Arguing against taxability is that a return of capital is only that -- it is only a return of capital, not a gain, and that taxing the return of capital might discourage needed investment, the more so if the return is taxed even when there is a loss.
One can raise other questions about what should be included in gross receipts. Should gifts be included? Inheritances (despite the estate tax? Only if the estate tax is eliminated?)? Insurance proceeds, including life insurance (which is presently non-taxable and has been used by the wealthy, their tax lawyers and their tax accountants to perpetrate gigantic tax avoidance scams)? All such questions have their own pros and cons, albeit the factor of not allowing the current intellectual and financial corruption at the deduction (and credit) level to be replicated at the gross receipts (or gross income) level would seem to be a constant.
A penultimate and obvious point: Having not been a tax lawyer for over 41 years, and reading about taxation only occasionally, my knowledge is limited. What has been said here must be expected only to scratch the surface. But the idea of a gross receipts (or gross income) tax, instead of our present income tax system, may not be prima facie nuts. It may possibly have some real merit in important ways, even though it would be a sea change in the system. People have been willing to consider the so-called flat tax even though, as proposed by Forbes, it would work a sea change and, apparently, is designed, or at least would operate, to benefit the rich by doing away with taxes on dividends, interest and capital gains received by individuals, letting corporations deduct every dollar of the cost of capital equipment in a single year, and letting landlords do the same for the value of their buildings. A gross receipts (or gross income) tax system could be considered far less radical than such a rich-benefitting flat tax in various ways, since it only eliminates deductions and credits while lowering tax rates, no doubt dramatically. So if a flat tax could be considered, why can’t a gross receipts tax be considered?
Certainly, something must be considered. As said earlier, the tax system has become horrendously complex, incredibly abused by the wealthy, and quite possibly immoral. It gives rise to continuing bribery of Congress by what has been called the political donor class. For these bribes, legislators -- who wish to stay in office forever, or at least until they leave to become highly paid lobbyists who bribe others who remain in Congress -- grant tax favors to the rich and simultaneously hobble the Internal Revenue Service. The hobbled IRS is incompetent anyway (like most of Washington). As part of its incompetence, it comes down really hard on small fry, whose lives it makes miserable, while often doing little or nothing about members of the political donor class who evade taxes to the tune of scores or hundreds of millons of dollars each, and while also doing little or nothing about people who simply stop paying taxes or even stop filing returns altogether. The whole system is vastly broken and is contributing to the transition of this nation to a plutocracy with a permanent ruling class of mutually-in-cahoots legislators and the rich, assisted by large elements of the media. Something needs to be done. Some new tax system which is simple and enforceable, in which people can therefore believe, and with which they will cooperate, is highly desirable if not absolutely essential. A gross receipts (or gross income) tax might possibly be a good answer to the problem, and at least it seems to be one that independent experts should think about in order to assess its pros and cons.
I've been enjoying your posts. re: your most recent one, aren't most state and local income taxes flat taxes, i.e. un-graduated gross income taxes? My township here in SE Pennsa. allows no deductions whatsoever and Pennsylvania and New York income tax deductions are minimal.
Here is something else to chew on: isn't the real problem with all policy questions the lack of accountability of our elected officials? They promised us a federal flat tax some years ago, if memory serves, but it never materialized. I like much of what Kerry is saying, but I just don't trust him or the whole Washington scene. Now, if Kerry were to post say a $10 billion performance bond (how much is his wife worth?) I would suddenly gain quite a bit more trust because he would have his family's net worth on the line. Part of the reason many Americans ignore politics is that there is no serious expectation that innovative policies will actually get implemented. Change that expectation and watch the fireworks! And I can think of no better way to make somebody really try to implement change than to put their future well-being at stake.
> Bob W.