SIMPLIFYING THE US TAX CODE – TAX ALL AMERICANS LIKE PENNSYLVANIA TAXES RESIDENTS

If we really wanted to simplify the convoluted mucking fess that is our US Tax Code we should look at a tax system based, with modifications, on the Pennsylvania state income tax.

The Pennsylvania state income tax is truly unique.  The state tax returns of most states with a state income tax follow the federal return and, for the most part, federal tax law – starting with federal AGI or taxable income and making state adjustments to this number.  PA had to be different.  It’s state tax system was created from scratch, with very little similarity to federal tax law.

PA taxes gross income at a flat rate.  There are no exemptions for dependents and no filing status differences.  The only deductions allowed are unreimbursed employee business expenses, deducted directly against wages, and contributions to a Medical Savings Account, Health Savings Account, Section 529 qualified Tuition Program account, and Pennsylvania ABLE account.  Retirement income – distributions from IRAs, 401(k)s, 403(b)s, Social Security and Railroad Retirement, and other pension or retirement plans – is not taxed, and contributions to retirement accounts are not deductible or considered “pre-tax”.   Net gambling winnings, after directly deducting losses to the extent of winnings, are taxed. 

Losses in one category are not allowed to reduce income in other categories.  Capital losses can reduce capital gains, but a net capital loss or a rental loss cannot be deducted from wages or interest and dividend income, as can be done, within some limitations, on the federal return. 

The only credits allowed that are not related to a business activity are a special refundable “Tax Forgiveness” credit, sort of like the Earned Income Credit (unlike the EIC, based on earned income, eligibility for Tax Forgiveness is based on eligibility income, which differs from state taxable income, that includes a variety of sources) and a credit for taxes paid to another jurisdiction (like the federal Foreign Tax Credit).

I would make three modifications to the PA system for the federal return –

(1) Add a standard deduction – greater than the current increased amounts – such as perhaps $17,500 for an unmarried taxpayer and $35,000 for a married taxpayer.  Or more. 

(2) Allow losses in one or more categories to be deducted against income from other categories to create a “net” total income.

(3) Not allow any “Tax Forgiveness”, or the current Earned Income Credit credit, refundable or otherwise.

Like the PA state return the new federal return would allow a deduction for unreimbursed business expenses of employees directly against wages.  And, also like PA, all pension and retirement account distributions would be exempt from tax (except for a transitional amount – see below) and net gambling winnings, after a direct deduction of losses, would be the amount included in total income.  Gross wages would be taxed, with nothing treated as “pre-tax”. 

There would be no “adjustments to income” other than the deduction for self-employment tax (self-employed health insurance premiums would be deducted on Schedule C or E), no itemized deductions, and no tax credits, except maybe the Foreign Tax Credit.  The tax rate, currently 3.07% on the PA state return, would be perhaps 12% of the net total federal taxable income, after deducting the applicable Standard Deduction.

The “transitional” amount of pension and retirement account distributions that would be taxed would be the remaining amount of applicable employee contributions that were treated as “pre-tax” or deductible on a prior Form 1040.  Going forward all pension and retirement accounts would be “ROTH-like” – no deduction or pre-tax treatment going in and no tax coming out.

It would be an almost pure “flat tax” system.

On the business front, I would make the changes that I discussed for corporations, Schedule Cs, Schedule Es, and pass-through income from sub-S corporations and partnerships in my book THE TAX CODE MUST BE DESTROYED.

Of course, this will never happen - thanks to lobbyists and the greed, and need for campaign contributions, of Congresscritters.

So, what do you think?

TTFN

SOME BACKGROUND ON A COMMENT

I just published a comment to today’s post on “Mitt’s Tax Plan” from tax professional Tom Kaminski (aka “Knobby”).  Here is what Tom said –

“All this talk about taxes makes my gut tell me that one, we probably will end up with having a VAT in America before 2017. And two, the tax code is going to end up being a complete mess, only because I don't see the mentality in Con-gress at the moment to fix it properly.

If they all really want a simple tax system they can go back some 25+ yrs. to when Hall-Rabushka first proposed their 19% flat tax system. They laid everything out including forms.”

Here is the word on the “Hall-Rabuska” flat tax proposal that Tom references (which was new to me) from the Tax Policy Center’s library, preceded by a description of “consumption tax”.

“Background

Consumption is income less savings. Thus, the only difference in principle between a consumption tax and an income tax is the treatment of the savings. An income tax taxes savings both when the money is earned and again when the savings earn interest. A consumption tax taxes saving only once: either when the funds are withdrawn and used for consumption or when the funds are first earned. Although this difference appears simple, consumption taxes come in many forms.

The Hall-Rabushka flat tax

In the early 1980s, Robert Hall and Alvin Rabushka of the Hoover Institution developed a consumption tax system that achieves some of the administrative advantages of a value-added tax (VAT) relative to a sales tax, while also partially addressing concerns that consumption taxes impose a relatively heavier tax burden on lower-income taxpayers.

The Hall-Rabushka system is often called the "flat tax": It assesses a 19 percent tax on all businesses (corporate or otherwise)—identical to the VAT, except that wages, pension contributions, materials costs, and capital investments are deducted from the tax base. Individuals (or households) are assessed a 19 percent flat-rate tax on wages and pension benefits above an exemption of $25,500 for a family of four. No other income is taxable, and no other deductions are allowed.”

Sounds like a plan worth investigating further.

BTW – I certainly agree with Tom when he says - “I don't see the mentality in Con-gress at the moment to fix it properly “.  As I continue to say - the current members of Congress are idiots.

BRING ON THE FLAT TAX!

I’m back!

(1) As promised here is my response to the contention of Kevin of NO DEBT PLAN that one reason we will never have a flat federal income tax system is because it would put accountants and tax professionals out of work -

As a long-time tax preparer I am not worried about how a simple “flat tax” would affect the tax profession. I do not believe that such a tax system would put me out of business, or even reduce my net income. I actually welcome such a tax system.

If I were to spend each day during the tax season preparing only 1040A forms, I guarantee that I would bill more fees, spend less money, reduce my potential liability, and have less agita to deal with both during and after tax-time. While I obviously charge a higher fee for more complicated returns, I make less profit per hour on these returns. I honestly believe that a true 1040-SIMPLE would increase both my efficiency and my bottom line.

In its report of a few years back, the President’s Advisory Panel on Federal Tax Reform (whatever became of them) often mentioned that complicated rules force taxpayers to use paid preparers, and the simplification they proposed would permit more taxpayers to be able to prepare their own returns.

While a flat tax system would make a tax return easier to prepare, I do not see my clients leaving me en mass to do their own returns. A majority of my current clients are fully capable of preparing their own tax returns under current law. They come to me because they do not want to be bothered with the task of doing it themselves. Because my fees are reasonable it is easier, and more cost and time effective, to have me do it. Plus they want to be sure they do not miss anything.

While a flat tax system would include a great deal of simplification, there would still remain enough complexity in certain areas of the tax code to keep us busy. I expect we would still need to prepare some kind of Schedule C for business income, Schedule D for capital gains and losses, and Schedule E for rental and pass-through income. Even though income is taxed at a flat rate, one still would have to calculate and report the income.

Even if the current Tax Code is greatly simplified, it is a proven fact that any change to the Code will increase business.

The only sectors of the tax preparation community whose income could possibly be affected by this simplification are CPAs with an extensive individual tax practice (but businesses would always need accounting services for a variety of internal and external non-tax purposes), and commercial preparation firms like Henry and Richard (although they, too, would profit as tax preparation became even more “assembly line”), whose fees in most cases are extremely excessive. Also with fewer things to audit tax professionals who specialize in representation would also need to adjust their focus. However I believe the average tax preparer will not be hurt, and will probably be helped, if a simple flat tax becomes the law.

I am curious to hear my fellow tax-preparing bloggers thinking on this topic.

(2) Also as promised I have dug up my old post about cell phones, which originally appeared under the title FINE WHINE –

“When visiting my “mail drop” the other day – Global Mail near Journal Square in Jersey City (also a client) – I noticed a sign at the counter:

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“PLEASE – NO CELL PHONE CONVERSATIONS WHILE AT THE COUNTER – THANK YOU”

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Kudos to my client! This sign should be prominently hung in every single business establishment and Post Office in America.

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I am constantly amazed that while waiting on line at the bank or Post Office the person who is at the window currently being served is carrying on a conversation on a cell phone. What idiots!

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As I have said before, in the “good old days” when you heard someone talking to himself/herself in the street it was because he/she was “not all there”. Nowadays, it is still because the person is “not all there”, only now he/she is talking on a cell phone.

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Whenever I ride a public bus or train I am forced to listen to one side of about half a dozen phone conversations, none of which are particularly interesting.

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I saw an excellent bumper sticker a while ago which read “GUNS DON’T KILL PEOPLE. IDIOTS TALKING ON CELL PHONES WHILE DRIVING KILL PEOPLE!” That is not a joke - I was almost run over crossing the street near my home when a person talking on a cell phone ran the red light.

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Every single theatrical production, lecture or continuing education seminar must now be prefaced with the instruction “Please turn off all cell phones.” There was never an announcement “Please do not stab the person next to you with a knife”. Only a person who carries a cell phone everywhere would be stupid enough to have to be told to turn it off in such a situation.

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There are only three (3) reasons why one should have a cell phone:

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(1) So that a babysitter is able to contact you while you are out to dinner or at a movie to let you know of an emergency at home.

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(2) So you can contact 9-1-1, the auto club, and/or your family if your car breaks down or you are involved in an accident (or to contact 9-1-1 for any other kind of emergency).

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(3) So you can call a client, or a friend or family member, if you are on the road and running late for a business or social appointment, or to ask for directions if you are lost.

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I dare anyone to name another legitimate reason.

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I had a cell phone briefly several years ago, for reasons number (2) and (3). I kept it in my car and it was stolen. I never replaced it – and have never missed it.”

Any comments?