Raymond Richman - Jesse Richman - Howard Richman
Richmans' Trade and Taxes Blog
Suggested Reforms of the Personal Income Tax
After passage of the 16th Amendment in 1913 authorizing enactment of income taxes, Congress enacted the personal income tax. Income had always been considered a good measure of ability to pay. The income tax was conceived as not merely a revenue source but could be used for social engineering. The first bit of social engineering was the taxation of income at progressive rates as a way of reducing income inequality. Another reason given was that very high annual personal incomes are basically undeserved resulting from what economists term economic rents.
But how progressive should the income tax be? That was a question not easy to answer. During WWI, the top marginal rate reached 92%. But that rate could not continue because of its anticipated adverse effect on investment. Reason suggested a better rule based on benefit and cost, namely, that in normal times, the top tax rate should not be higher than the rate that at which the negative effects on the economy equaled the perceived benefits of reduced inequality. No one knows how to determine that rate.
Reform proposals include a reduction of the number of tax brackets from currently seven to three. This does not simplify the calculation of the tax at all. Regardless of the number of brackets, once taxable income is calculated the calculation of the tax liability is simple involving at the most calculation of the sum of two numbers. Reducing the number of brackets interferes with the progressivity of the tax. Over wide ranges of income the tax rate becomes constant with those at lower levels of the income brackets paying the same rate as those at the highest level of the range.
In any case, progressive taxation has been in existence since the first days of income taxation. Congress, soon after the 16th Amendment was adopted in 1913, learned that they could conceal in the income tax code and regulations all kinds of subsidies that benefitted selected constituents. That made it unnecessary to show in the budget how much those benefits, called tax expenditures by economists, cost taxpayers. What followed is that Congress passed bill after bill adding thousands of pages to the personal income tax law which encompassed about 500 pages in 1930 and now covers 2652 pages. Some estimate that the internal revenue code and its regulations cover 74,000 pages!
As the Tax Foundation points out, Over the decades, lawmakers have increasingly asked the tax code to direct all manner of social and economic objectives, such as encouraging people to buy electric and hybrid vehicles, turn corn into gasoline, purchase health insurance, buy a home, replace that home's windows, adopt children, put them in daycare, purchase school supplies, go to college, invest in historic buildings, spend more on research, and the list goes on.
But some tax deductions should be left intact. They result from the fact that we are a federal system. The States created the Federal government and gave limited powers to the central government. As Justice Marshall stated in McCullough vs. Maryland -- the power to tax involves the power to destroy. The deduction of mortgage interest and real estate taxes on homes occupied by their owners need not concern the federal government. They are the concern of State and local governments. Local governments tax the value of real estate, a tax which we believe is the best tax local governments can levy. Including mortgage interest and local taxes on homes would seriously reduce the value of homes and the tax base of local governments.
The principal reforms that are needed are the following:
Another tax reform that we shall consider in a later blog is the proposed elimination of the Estate Tax. The Estate Tax is important in reducing the increasing inequality of wealth over time. It is one thing to reward the inventors of products with huge wealth. It is quite another to perpetuate those difference in wealth beyond the life of the productive individual who earned his wealth.
Americans deserve a single income tax applicable to all taxpayers. It should be simple enough to define what income is. Income consists of wages and salaries, rent, interest, profits and realized capital gains. One could make a case for not taxing realized capital gains as income if the proceeds are rolled over into a comparable investment asset which we have long recommended.
Comment by Larry Walker, 7/31/2017:
I agree, the tax expenditures created to redistribute wealth need to go. Their elimination in itself would create more of an ecomonic incentive than they create, plus allow consumers to make vested decisions. Not taxing capital gains, or at least allowing a positive basis adjustment for inflation during the period of ownership would be a big plus. ( https://larrymwalkerjr.blogspot.com/ )
Response to this comment by , 8/4/2017:
Real Estate Taxation
Journal of Economic Literature:
Atlantic Economic Journal: