A Critical Review And Analysis Of The 3 Systems Of US Taxation Proposed By President Bush’s Advisory Panel On Federal Tax Reform; US Federal Income Tax, Proposed flat tax And Proposed National Sales Presidents Bushs Advisory Panel has proposed three systems of US taxation due to unacceptable state of the U.S. current tax system. These proposals were made to identify the most important problems in the U.S. nations tax code and to recommend the most appropriate options to make the code fairer, simpler, and more conductive to the U.S. economic growth. Since the last tax reform bill passed in 1986, there have been over 15,000 changes to the U.S.
tax code; however, all these changes were unable to provide the U.S. nation with the best options to reform the tax code. So, in order to express a desire for change, there has been made several proposals concerning the reform. The paper, therefore, provides a critical review of these three proposed options to make the U.S. tax code function properly U.S. Federal Income Tax, Proposed Flat Tax, and Proposed National Sales. There were numerous proposals to make drastic changes in the U.S.
taxation system. These proposals were predominantly aimed to call for a fundamental reform of the U.S. federal income tax program (FIT program), especially that concerns individual taxpayers. Democrats adhered to the idea to retain a steeply progressive set of income tax regulations, where the upper income individuals were subjected to taxation more heavily than the working poor and middle class individuals. Democrats also argued for increasing taxes on private enterprises by reducing some corporate tax incentives they referred to as “corporate welfare. On the other hand, Republicans adhered to the idea to adopt a so-called ‘flat tax’ that would allow low income families to be exempted from income taxation, while all other citizens would be taxed at a low flat rate.
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The first proposal, flat tax, relates to so-called consumption taxes, aimed to make the U.S. taxation system simples and encourage saving by discouraging spending. Flat tax refers to the taxes on earning, but not income from investment and savings. There has been a debate concerning the flat tax proposal, as well as the effectiveness of this taxation system. Although some politicians considered that flat tax will evidently make the U.S. taxation system simpler, and more effective, some of them argued against flat tax and claimed that flat tax affronts the popular and traditional principle that the tax bill should be based on the ability to pay.
So, those, who argued in support of flat tax, claimed that new thinking is evidently required, and the U.S. government should fundamentally rethink the way in which income is taxed in order to create the efficient system that is equitable and pro-growth (Mack, p.3).
According to them, flat tax would be levy a single tax rate on all income subject to taxation. Therefore, the income will be taxed only once. In addition, the unfairness and complexity that occurs in result of various credits, exemptions, and deductions will be eliminated, and the tax rate will be as low as possible. Only a dependent deduction and personal allowance will be permitted.
The basic principles of the proposed flat taxation system are as follows. First, the taxpayers will be fully informed on what is being tax, and how they are being taxed. The taxes, therefore, will be as visible as possible. No hidden taxes will be allowed. Under the proposed tax systems all the individuals will be treated equally, and no differentiations in tax liabilities based on the uses of income or the sources will be allowed. The tax system, therefore, will provide the similar taxation for similar economic actions and transactions, taking into consideration no attributes of the taxpayer (Mack, p.4).
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The tax system will be as simple as possible, as complexity makes the U.S. taxation system very expensive and punitive, thus resulting in efficiency loss to the U.S. economy in general (Hall, p.114).
Under this proposal, the flat tax system will be neutral in economic decision making, and will not interfere with the free will economic decisions and choices of businesses and individuals. Finally, the flat tax system will raise revenues, as the taxpayers will gain confidence in the U.S. law as in exists when planning and entering into transactions (Mack, p.5), and will make the U.S.
tax code competitive with other world nations, as it impedes no free flow of goods, services and capital across the U.S. borders. So, according to the supporters of flat taxation system, the U.S. nation needs flat tax, as current U.S. tax system is needlessly complex, confusing, and unfair. The U.S.
current tax system levies different tax burdens on the people with the same incomes. In addition, it takes the U.S. citizens six billion hours each year, at t cost of $200 billion, just to comply with the tax code. Flat taxation system, therefore, is the most effective solution to this problem. However, flat taxation system is not as effective as it may seem to appear. There have been many politicians opposed to this system due to plenty of reasons.
First, the simplicity is evidently put into doubt, as initiating the transition from the current tax system to a flat taxation system will give birth to countless complications. The process of transition will not be smooth; on contrary, it will create plenty of complications. For example, it is not clear, whether the deductibility of home mortgage interest will be eliminated for all “homeowners regardless of when they purchased their property, which might be perceived as unfairly changing the rules in the middle of the game (Tax Reform Proposals: Strengths and Weaknesses), or whether it will be somehow phased. There will be plenty complex issues like that, especially in changes in the U.S. regulations affecting depreciation, capital gains, corporate interest expenses, and many others. The next subject at issue is the fairness of the flat taxation system.
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The flat tax will provide an enormous windfall to the wealthiest citizens, due to reduction in the top tax rates and eliminating taxation of the investment income that is mainly collected by the families with the highest incomes (Tax Reform Proposals: Strengths and Weaknesses).
In result, the flat tax will be less regressive than a pure consumption tax, and, at the same time, less progressive than the current U.S. taxation system. Next, according to the Treasury Department analysis, the taxes will be reduced for the wealthiest citizens (for those in the top 5 percent of the income distribution) for about 1 percent (Tax Reform Proposals: Strengths and Weaknesses), and, at the same time, will increase the burden for all other people, as in average, the tax rate will be increased for about 20 percent. It will occur predominantly due to the exemption of the investment income, the elimination of graduated rates, and the demise of Earned Income Tax Credit (Aaron, p.7).
Finally, some citizens will have an opportunity to avoid corporate tax, despite the cheerful promises of those, who proposed flat tax reform as the best possible way for the country’s economic growth. The second proposal, National Sales Tax, also relates to so-called consumption taxes, aimed to make the U.S. taxation system simples and encourage saving by discouraging spending, and refers to the taxes levied at the point of transaction.
According to those, who argued in support of national sales tax, this tax will add a surcharge to the cost of retail services and goods, where the rate that replace the current income tax, will heavily depend on the scope of services and goods subject to the levy. For example, exempting college tuition, housing, and health care “while providing even limited relief to low-income households would require rates exceeding 30 percent (Tax Reform Proposals: Strengths and Weaknesses).
It should be also taken into account that, when all the services that would be administratively difficult to apply the national sales tax to, and all politically untouchable transactions will be excluded from taxation, the national sales tax will be as high as 56 percent to match current revenue collections. Yet, those, who argue in support of national tax proposal, consider that the rate will be about 17 percent by including all transactions. What concerns simplicity of the proposed national sales taxation system, the major arguments in support are as follows. Firstly, the individuals (except of the self-employed persons) will no longer be obliged to file tax returns. Secondly, both businesses and individuals will have an opportunity to save their money they are forced to spend on the lawyers and accountants to invent tax-cutting strategies and to resolve the disputes related to the complexity and intricacy of the current income tax code.
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However, the situation is not as favorable as it may seem. The opponents of the national sales tax consider that even in case national sales tax covers all kinds of transactions, with no exceptions, administrative costs will be still very high, as some verification process would be needed to make sure taxes were paid in full on all sales (Tax Reform Proposals: Strengths and Weaknesses).
In addition, as the national sales tax will be quite high, some individuals and businesses will offer tax-free sales and off-the-book sales in order to cut their taxes to the lowest possible rate, thus being conductive to creation of an underground economy. Next, in case the U.S. Congress exempts some services and goods from taxation (as it is proposed by the national sales tax), administrative challenges will become even more complex (Tax Reform Proposals: Strengths and Weaknesses).
As it is claimed by the opponents of the national sales taxation, in case sales taxes are applied to groceries other than food, it will greatly complicate the task of assuring proper implementation of the system (Tax Reform Proposals: Strengths and Weaknesses).
At the same time, those politicians, who support national sales tax, understand that this system will be less favorable to the taxpayers will low incomes, and offer various subsidies to those who will be hurt the most.
However, these subsidies will create additional complexities as the government will have to define the rate to be paid individually, as well as to find solutions on how to avoid false claims for subsidies. It should be also taken into consideration that the vast majority of world countries try to avoid national sales tax because of the increasing number of administrative problems. As it is claimed by the opponents of the national sales tax, “a 30 percent rate for such a national tax would be more than three times as high as the largest sales taxes that have proven to be administrable, and at that level tax evasion would be lucrative and difficult to monitor (Tax Reform Proposals: Strengths and Weaknesses).
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What concerns fairness, the proponents of the national sales tax consider that in case the system is implemented properly, the citizens and businesses who consume equally will be taxed equally, and, application of the sale sales tax to those who spend the same amount will be viewed as fair. At the same time, the national sales tax will be aimed at deterring excessive spending and will not penalize the families or individuals who save a higher share of their earnings by taxing the income on those savings (Tax Reform Proposals: Strengths and Weaknesses).
However, the opponents of the national sales tax consider that the national sales tax, even in case there will be exemptions for necessities, will be regressive. Next, as the vast majority of families with low incomes are either subjected to no taxation, or have subsidies through the Earned Income Tax Credit, they will be hurt at most, when the national sales tax will be applied.
In case the government decides to help them and to implement additional subsidies, this will evidently make the system even more complicated. In addition, the families with children who have to spend more on their children, compared to the families with no children, will have to pay higher consumption tax. At the same time, the current taxation system is aimed to help the families with children, as it allows more directly for the added cost of children. It is also quite difficult to claim that savings rates would rise if a consumption tax were to replace the income tax (Tax Reform Proposals: Strengths and Weaknesses).
Finally, it should be taken into consideration that (in relation to both national sales tax and flat taxation model) the reality significantly differs from the theoretical long-term conclusions, and it will be very difficult to implement both systems into life, while managing to make these taxation systems simple, effective, and conductive to the future economic growth and prosperity of the U.S. nation. So, the best proposal is, probably to adhere to the more progressive and neutral income tax. The major features of these proposals are as follows.
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The 70% of taxpayers who currently pay a marginal rate of no more than 15% will owe only 10% on taxable income. Marginal rates for many of the taxpayers in higher brackets will increase. Next, the taxable income of workers will be significantly expanded to include state and local government bond interest and pension contributions. Next, according to the proposal, capital gains will be fully taxable and no exceptions will be available (Altig et al., p.8).
Only the home mortgage interest deduction will remain, and the vast majority of credits, except foreign tax credits and the earned income tax. Finally, the corporate tax structure will remain almost with no changes; however, the tax breaks for businesses (so-called corporate welfare) will be eliminated.
Similar to the previous taxation models, this taxation system has both its pros and cons. As the supporters of this taxation model claim, the system will be very simple, as the low tax rate of 10%, along with other changes, will diminish the “relevance of taxes to financial decision making for most taxpayers (Tax Reform Proposals: Strengths and Weaknesses).
The system will be quite fair, as it will be more progressive than the current taxation system, and will have less opportunities to cheat. Finally, the economic incentives will also be positive, as reducing taxes for the families with low and middle incomes will boost their disposable income and spur consumption that, in its turn, will stimulate the U.S. economic growth. Yet, there are several limitations of the proposed model. It should be taken into consideration that the corporate tax will remain as complex as it is now.
Again, the transition to the new system of taxation will be complicated, and new paperwork will be created through adding employer-provided benefits and state and local government bond income to the income subject to taxation. In addition, the system may seem unfair, as the families with higher income will have to pay higher taxes, as if they are being punished for their productivity. Finally, the increased taxes on the individuals with high incomes in general and on capital gains in particular may result in a stock market sell-off that can slow the U.S. economy. Works Cited Aaron, Henry J. “Like Most Overhaul Plans, Easier Said than Done.” Brookings 8.1 (1998): 7. Altig, David, et al.
“Simulating U.S. Tax Reform.” National Bureau of Economic Research Working Paper 6248,, October 1997. Hall, Robert E. The Flat Tax. Stanford, California: The Hoover Institution Press, 1995. Mack, Connie.
“The Flat Tax: Vital For America’s Future.” The Flat Tax: Vital For America’s Future. July 1995. Tax Reform Proposals: Strengths and Weaknesses. 21 November 2007 ..