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Income Taxes (a Government Finance Issue)
The government needs to regulate employment to ensure that employees have a safe place to work and are being treated fairly, and to regulate investments to ensure that businesses are run properly and that investors are treated fairly. In addition, a major part of the job of each of our governments is to protect us and our belongings. Someone who earns a lot of money could save, invest or buy a lot of stuff that would then need to be protected. Since we want to try to pay for our governmental operations with tax money that comes from the things that it supports, the idea of taxing our income makes a lot of sense.
The more someone earns, the higher the percentage of their income could be available to go towards savings, investments and luxuries instead of paying for necessities. Someone with a low income may not even earn enough to pay for things like food and rent, so might have very little that would need to be protected. Someone with a very high income could pay for all their necessities with just a tiny fraction of their income, so almost all their income would go towards things that needed to be protected. Since high income earners would end up with more to protect, then having higher income tax rates on higher incomes also makes a lot of sense.
In some ways, our income taxes act somewhat like premiums on insurance, which includes getting preventative care, protection and justice. Although it does not include restitution for losses. Therefore, instead of income taxes, another option might be to have some sort of property or wealth tax on our savings, our investments and our belongings. If we have separate property and wealth taxes, then, we could have lower income tax rates.
There are a couple of key differences between income and property taxes. With income taxes, the government basically gets all the money up front, but you get lifetime coverage. With property taxes, you would need to keep paying them on a regular basis for as long as you own the property. In addition, income taxes are simple in comparison to having property taxes on all your savings, investments and belongings. Therefore, except for a few items that need extra regulation and protection from the government, it seems to make more sense to have income taxes. However, the right balance of both is probably best.
Currently, income taxes are paid by businesses and individuals based on the amount and type of their income offset by certain deductions. There are four serious problems with our current income tax system.
- There are so many tax brackets and deductions that it can make it too complicated for the average person to understand and to figure out what they owe. This can lead to mistakes that result in many of us overpaying or underpaying our taxes or paying to have our taxes done for us.
- The complexity of our income tax laws and forms makes it easier for dishonest individuals and businesses to cheat on their taxes. In addition, it allows criminals to submit bogus income tax forms in our names to cheat the government and in turn us out of the amounts of their fraudulent income tax refunds.
- With numerous income tax rates, the same deduction amount can benefit higher income individuals more than lower income individuals, since the higher income individuals can deduct the amount from income that would have been taxed at a higher rate.
- For the most part, the same income tax rates apply equally to the income earned from a variety of different sources, even though some income sources require more protection from the government than other income sources and should therefore be taxed at higher rates.
The solution to our income tax problems requires two major changes. These include splitting our income taxes into different types of taxes based on the income's source, and simplifying the way each tax type is calculated and paid.
Currently, Income Taxes apply to both individuals and businesses, and apply to the income earned from a variety of sources. These income sources include those from our salaries and wages, the interest, dividends and other returns on investments, and the profits from the sale of goods and services. However, each of these sources of income are very different in both how the income is earned, and in what government services are needed to protect those sources of income. Therefore, it makes sense to treat each one separately.
First off, wages and salaries are paid for us doing some combination of mental and physical labor. They can be in exchange for work being done or for the time performing the work. In general, there is little financial risk in this type of income, since if we do the work, then we are entitled to our earnings and should get paid, and the government should be there to back up our claims. Nevertheless, we could get laid off, so we may not have a guarantee of future earnings, or our employer could go bankrupt and not have enough money to pay us.
Although, this source of income does not carry the same risk of financial loss that most other sources of income have. To get some better and higher paying jobs, we do need to invest some time and money into getting the right type of education. Therefore, one might suggest that we should get some form of deduction for our education. However, the payoff for investing in additional education comes from the higher wages or salaries that we get for that education.
We can also work as independent contractors such as inventors, writers, artists or any number of other types of work where we will produce something that we will sell as opposed to working for an employer. In these cases, we are more entrepreneur than employee, and I think it makes more sense to handle this income as we would for the profit from a business. However, we could set things up so that we pay ourselves a wage or salary, so we may then end up with both wage or salary income and business income.
In addition to the taxes on wage and salary income going towards protecting the money we earn, it also needs to go towards things like education, jobs programs, labor relations, and other things our governments must do when dealing with employees and employers.
To earn interest or returns on investments, we need to have some money to invest. Unless we have inherited the money, or have been given some money as a gift, we may first need to work to earn some extra money that we can then invest. In the case of investment income, our earnings are limited by the amount of money we can invest and how well we invest our money. In general, investment income is not dependent on the amount of time we can work. All investments have some financial risks associated with them, so we should be allowed to offset our earnings with any appropriate losses.
Along with investing in things like stocks and bonds, we could also invest in things like real estate, art, antiques and collectables. Like stocks and bonds, these things can be bought and sold, and we can earn or lose money on them. However, except for real estate, most of these do not have the same ownership controls on them. That is, there is no established registry of who owns what and what price we paid for them. These controls should be added to better handle the income taxes on them, and to help prevent some forms of fraud.
Gambling could also be considered a form of investment. However, it generally involves much higher financial risks and does not support any productive economic activity, and really should be considered more entertainment than real investment. Therefore, although we can treat gambling as a form of investment when it comes to income taxes, it already requires more government regulation, and we should add some additional controls. This means we should have some appropriately higher income tax rates on any winnings, and some additional taxes on the gambling businesses to pay for the cost of these additional controls.
For investments, we need to keep the needed records to show who owns what, how much we paid for the investment, when we bought it, and how much we sold it for. Offsets against earnings should be allowed for losses that have previously occurred with the same type of investments, but there needs to be appropriate time limits on when those losses can be used.
In addition to the taxes on investment income going towards protecting the money we earn, it also needs go towards keeping the investment records, and to supporting the regulatory agencies needed to oversee the businesses involved in providing and managing our investments.
Businesses may need to spend a lot of money to cover the fixed and variable costs they need to incur to produce and to sell their goods and services. To show a profit, a business needs to earn more than it spends. Since a business could lose money instead of making a profit, a business should be allowed to offset current profits with some appropriate past losses.
In general, only the earnings above and beyond the costs incurred to run the business should be taxed as income. However, not all the money that could be spent by a business should be allowed to be deducted. For instance, if a business spends money on providing owners or employees with things like a company car, parties or other benefits that are not normal costs of doing business, then they should not be able to avoid paying taxes on that income. Either the business must pay the income taxes on those amounts, or report them as dividends and/or wages, and have the owners and/or employees pay the appropriate income taxes on those amounts.
In addition to the taxes on business profits going towards protecting the money a business earns, it also needs go towards supporting the regulatory agencies needed to oversee the businesses, commerce, trade, and stocks and bonds, to inspect their workplaces and their goods and services, to handle employer and employee relations, and to protect the investors and the environment.
Since these different types of income are earned in different ways, and need to support different government services, the income taxes on them should be handled separately. Therefore, in this section, I will talk about the taxes on Wages and Salaries, which would be our Personal Income Taxes, and then talk about the Investment Income Taxes and Business Profit Income Taxes in upcoming sections.
With our Income Taxes separated into 3 different income types, our Personal Income Taxes would only apply to our wages and salaries. However, it may be best to stagger our changes over time to give everyone a chance to make a smooth transition. If so, the first step might be to implement as many of the changes as we can to our existing Income Taxes. After the existing Income taxes are separated by income type and partially simplified, we would complete the conversion and simplification of our income taxes and gain the additional benefits that would come with those changes.
We would start by segregating our income by its type. Even though we would still be filing one income tax form, we want to be able to tax each type of income in the appropriate way and at the appropriate rate. Therefore, the tax form would have sections for calculating the income tax on our wages and salaries, for calculating the income from interest, dividends, and other investments, and for calculating the income from business profits. The separate income tax amounts would then be summed together to come up with the total income tax amount.
For our wages and salaries, we would first reduce the number of tax brackets. For instance, the taxes on our wages and salaries could have just four income tax brackets. There would be a very low rate or no tax on income up to what would be needed to get out of poverty. A low tax rate would apply to income above the poverty level and up to what would be considered a low middle class income. A medium tax rate would apply for anything above a low middle class income level and up to a high middle class income level. A high tax rate would apply to any income that is above the high middle class income level, which would put someone into a high-income level.
Instead of just four tax brackets, we may want to add a fifth tax bracket to cover any ultra-high income. There are really few valid justifications for someone earning a wage or salary in the multi millions of dollars a year. If it cannot be shown how an ultra-high income is justified, then it should be taxed at an ultra-high rate. Of course, instead of paying someone an ultra-high wage or salary, it might be better to award a bonus for or a share of the extra profits that the person brings in. That gives more incentive to do a good job and saves the business some money in case the person does not do a good job.
We would also reduce the number of tax brackets for the Investment income and Business Profit sections of the Income tax form. However, we would not have a tax bracket with a zero-tax rate in these sections, and the other rates may be higher or lower depending on what we determine to be best for each type of income. There could also be a separate section for gambling income, since we should tax it at higher rates than other types of investment income.
To reduce or eliminate any double taxation of dividends, businesses should be given a deduction for the dividends they pay out. To encourage long-term investing, sales taxes could be applied to the selling of investments, which should discourage frequent investment turnover. If we have a sales tax on investments, then we could appropriately reduce the income tax rates on investment income and not need separate rates for short-term and long-term gains.
Currently, the value of a deduction for a given taxpayer is dependent on their maximum tax rate. A low-income taxpayer may not have any income taxed at more than 10%, but a high-income taxpayer may have some of his or her income taxed at 37%. Therefore, the same charitable contribution of $100 might earn a low-income taxpayer a $10 tax reduction, while giving a high-income taxpayer a $37 tax reduction. Of course, this assumes that these taxpayers had sufficient deductions to exceed the standard deduction, since their deductions would not help if they did not. Of course, it seems more likely that a high-income taxpayer would have sufficient deductions.
An extreme example might be a billionaire who could easily afford to donate $100 million dollars to some given charity X. This donation might reduce his or her taxes by $37 million, which means his or her contribution would only really have cost $63 million. The remaining $37 million would indirectly be paid by us out of our tax dollars. In essence, we would all indirectly be forced to contribute to charity X. This would happen even if most of us taxpayers would rather have our money go to other charities, or even if we completely disapproved of charity X.
This is unfair on many levels. First, the charitable contribution is more expensive for the low-income taxpayer than the high-income taxpayer, $90 versus $63 for each $100 contributed. Second, all taxpayers are being asked to subsidize certain charities whether they want to or not. We need to leave it up to each of us to decide what charities are worthy of getting our money. If we want to donate to charity, we should give what we can afford, and not consider whether we can get a tax deduction for it or not. Therefore, we should eliminate this deduction.
Another deduction that unfairly helps the high-income taxpayer more than the low-income taxpayer is the mortgage interest deduction. Not only is a high-income taxpayer more likely to own a home instead of renting, but for each $100 of mortgage interest paid, it only costs the high-income taxpayer $63 while costing the low-income taxpayer $90. In this case, instead of being forced to subsidize some potentially worthwhile charity, we are being forced to subsidize rich folks so that they can live in larger and more elegant mansions. At least the mortgage interest deduction is now limited to new purchases with loans of $500,000 or less. Nevertheless, we should also eliminate this deduction.
If we did decide that it was important to help us to buy our own home, we should replace the mortgage interest deduction with something that was handled separate from income taxes and that was made more equitable. For instance, with certain appropriate restrictions and conditions such as limits on home values and personal income levels, we could get a break on the real estate taxes we had to pay when buying a primary residence. This tax break would be phased out as property values and our personal income levels rose.
We can also look at the case of deductions for state income, sales and property taxes. Not only do these deductions primarily help higher income individuals, but they also give states with higher taxes a federal subsidy that indirectly comes from states that have lower taxes. It really shouldn’t matter that we pay state income, property, sales or some other taxes when we pay our federal income taxes. At least, the deduction for these state and local taxes have now been capped at $10,000. To be fair, we should simply eliminate these deductions altogether.
The idea would be to have all deductions eventually handled separately from our income taxes or eliminated entirely. During a short transition period, some deductions would remain. However, the amounts should be limited to the amount of income that was taxed. In addition, as appropriate and as is done now, some deduction amounts should only be included if they exceeded some dollar amount or percentage of income and should be limited to some maximum dollar amount. Then, the eligible deduction amount should be multiplied by a certain single percentage that would be less than or equal to the lowest tax rate and then subtracted from the tax amount.
Couples currently have the option to file a joint income tax return or to file separately. Depending on the relative incomes of the couple, one or the other methods may result in lower taxes. I have also heard of couples divorcing at the end of each year and then remarrying in the following year to file as singles to reduce their taxes even further. Not only does this cause a lot of extra work for many couples, but it is fundamentally unfair.
Each wage or salary earner should pay taxes on their own income. This would simplify the tax returns by only needing one filing status and one set of tax rates. In addition, by having everyone use the same filing status, this would not let the government use our income taxes to add a marriage penalty or benefit and would help to keep the government out of our personal lives.
Our Income Taxes have a deduction for dependents. This changed somewhat for 2018, but the deduction remains. However, whether you choose to have children or take care of others that are dependent on you is a personal choice, and we should not let the government give incentives for choosing to have children. Given our planet's overpopulation problem, it would be better to impose a penalty on couples who have more than two children.
Again, we want to keep the government out of our personal lives. Each one of us should decide whether we want children or not, and whether we can afford to take care of them or not. We should not be forced to support other individuals' decisions to have children. Therefore, we should eliminate this deduction.
Another big savings for taxpayers would be to file one tax form for all income taxes instead of filing separate federal, state and local forms. A taxpayer would first compute their income, deductions and federal tax amount. Once they have their federal tax amount, they could simply multiply the federal income tax amount by a percentage to give them the amount for their state and local income taxes.
For instance, a taxpayer might live in a state that wants an income tax equal to 40% of the federal amount and live in a city that wants 10%. If this person’s federal income tax turned out to be $10,000 then they would pay $15,000 in taxes. The federal government would keep $10,000, and send the state $4,000 and the city $1,000.
However, the state and local taxes would need to be computed on sperate attachments, since the state and local governments may want to include or to exclude some income that was excluded or included as income on the federal form. They may also want to have other adjustments made before computing the tax amount. That means there would need to be a state income tax attachment for each state that had an income tax, and a local income tax attachment for each local government that had an income tax. Of course, these attachments could still be a lot simpler than the separate forms we have today.
One additional idea that might help reduce our national debt would be to make the income tax rates dependent on the size of our national debt. When our national debt was below some threshold amount, only the standard income taxes would be assessed. As our national debt increased past certain threshold amounts, additional income taxes would be assessed.
For instance, an additional one percent income tax might be assessed for each national debt threshold amount reached up to some maximum percentage. Not only would this provide an automatic means of raising additional taxes to pay down the debt, but it would provide most of us with an added incentive to encourage our representatives to keep our national debt low.
Although the precise income tax brackets and rates would need to be based on precise economic data and what, if any, deductions are still allowed, we can use some sample tax rates to demonstrate a few examples of computing the income taxes on wages and salaries. Although investment income and business profits may initially be on the same income tax forms, I will hold off on showing examples of those types of income until I talk about them in the upcoming sections.
In these examples, we will use some simple easy to use rates for some sample income brackets that are higher than they would most likely be, except for the lowest bracket. In these examples, we would not tax income up to $10,000, the next $20,000 would be taxed at 10%, the next $200,000 would be taxed at 20% and any additional income would be taxed at 30%.
In these examples, we would use the lowest income tax rate of 10% for any deductions. (Note: All deductions should eventually be eliminated, but I will include them here to show how they would be handled until they are phased out. In addition, I used some higher-than-expected amounts to show how a taxable income limit would affect the eligible deductions. We most likely would also include some deductions for dependents during the transition period but limit them. However, I will ignore them in these examples.)
In these examples, we will also assume a State Income Tax rate of 20% of the Federal tax amount and a County Income Tax rate of 10% of the Federal tax amount. Given our current high national debt, we will also add in a sample 10% National Debt Reduction (NDR) tax.
- Income: $10,000, Deductions: $5,000
- Income: $60,000, Deductions: $10,000
- Income: $100,000, Deductions: $150,000
- Income: $1,000,000, Deductions: $150,000
When these income tax changes are implemented, the dollar cutoffs for the new tax brackets and the tax rates would need to be appropriately raised or lowered. They need to be based on what will generate the revenue needed to fund the appropriate government programs and services without the government going into debt, and what makes best sense for our economy.
After an appropriate number of years, we would transition from our current Income Tax mess, through the simplified Income Taxes above, and to the three separate types of income taxes. The first of these three types of income taxes would be the one for wages and salaries.
If we are successful in eliminating all deductions and making the wage and salary income taxes simpler and fairer, we could make one additional change that would simplify things a little further. Since all our wages and salaries would be reported to the government, and there would be no other things that would affect the amount due for our wage and salary income taxes, the government could simply compute the taxes and send us a refund of any overpayment or a bill for any underpayment.
If we only worked for one employer for the entire year, and that employer made the right adjustments to the taxes withheld from your final paycheck, then we could end up having paid just the right amount of taxes. However, in most other cases, we would be due a refund or owe more taxes. Therefore, if we thought we might end up owing taxes at the end of the year, we may need to have one or more of our employers withhold some extra amount for our taxes.
The above changes to our Income Taxes would go a long way towards simplifying our taxes, which would make them easier to understand and to pay without also needing to pay a tax preparer. In addition, these changes would make them fairer, since we would not have all the inequities involved with any deductions. However, we can do better.
First off, we could switch from basing our wage and salary income taxes on what we earn from all our employers, if we had more than one, to basing then on what we earn from each employer separately. Then, we could switch from basing our income on what we earn for the entire year, to what we earn each day, week, or other appropriate pay period. We could do this since there is nothing special about basing them on what we earn for a given year (January through December).
With the above two changes, our Wage and Salary Income Taxes would work like this. Each of our employers would calculate our wages or salaries for the pay period, and then calculate what income taxes we owed on those wages or salaries. Our employers would then deduct the income taxes from our earnings, send the income taxes to the government, and pay us the rest. This may sound like what is done today, but the amount of income tax deducted from our pay would be the actual amount and not an estimate.
With this Wage and Salary Income Tax method, there would never be any additional amount owed or any overpayment requiring a refund. This means we would never need to file a wage and salary income tax form, pay any additional taxes, or wait for a tax refund. This also eliminates the possibility of being audited, at least for our wage and salary income taxes, and prevents anyone from filing a fraudulent tax return in our names. However, our employers could still get audited, and we would still need to verify what our employers paid us and what they withheld in taxes.
Of course, the calculations for these wage and salary income taxes would need to be a bit more complicated to be fair, but at least they would be done by our employers or their accountants instead of us. The reasons for why these wage and salary income taxes would be more complicated include the fact that not all employers have the same pay periods, some workers may have multiple employers, and may work a different number of hours during different pay periods.
The first thing to do is to come up with a standard period to base the income taxes on. Although it might seem like it would be best to use a week as the basic period, since most pay periods are one or two weeks. However, that would mean we could have issues with trying to deal with cases where someone is paid for a day at a time or paid once or twice a month. Therefore, it may be best if we calculate our wage and salary taxes daily.
If we use the tax brackets and rates from our earlier examples above, and for simplicity’s sake, we calculate the daily brackets based on someone working 5 days a week for 50 weeks, we can come up with some example brackets and rates for a day's wage or salary. With this, there would be no taxes on the first $40, a 10% rate on the next $80, a 20% rate on the next $800, and a 30% rate on everything above $920.
If we worked fewer days per year, then we would pay a little bit more in taxes than someone who earned the same amount but worked more days per year. If we worked part time at two or more jobs each day, then we would pay a little bit less than someone earning the same amount, but at a single job on that given day. With this, we could try to take advantage of the fact that earning the same amount at multiple jobs would reduce our wage and salary income taxes, but I do not think it would really be that helpful for us to do that.
Let's say we earn $20 an hour and work 8 hours in a day, which would pay us $160. With one employer, we would pay $20 in wage and salary income taxes. On the other hand, we could earn the same pay by working 2 hours each for 4 different employers and not owe any wage and salary taxes. It seems like we could save $20 dollars but working 4 jobs a day could end up costing us more in time and money getting from one employer to the next. Therefore, I do not think this should be much of an issue.
The pay period for most employees would probably be weekly, semi-weekly, bi-monthly or some other multiple of days. The best thing would be to require wage and salary income taxes to be calculated based on the actual hours and amounts earned each day. In some cases, when we get a fixed salary, our actual hours are not tracked. In those cases, we might allow the taxes to be calculated based on the average amount that we would earn per day based on the number of days that we are expected to work per that pay period.
We also need to decide how to handle the wage and salary income taxes on our commissions and bonuses. Although we might be awarded on a given day, the amount most likely would be for work we did over many days, weeks, or months. Therefore, we should probably allow these amounts to be divided over the number of days for which they were earned, recalculate each day's pay, and tax amounts, and then pay the sum of the additional taxes that would have resulted. However, unless we were a low wage or salary earner, and the commission or bonus is comparatively very large, it should not really make much difference whether our taxes were computed over some number of days or for the given day.
Investment Income Taxes -
Making paying our Investment income taxes simplier and fairer.
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