Friday, June 29, 2018
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?