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MY POINT OF VIEW
The Taxing Devil You Know
by Knight Kiplinger If you could create a national tax system from scratch, it likely wouldn't bear much resemblance to America's system today. It would enable people and businesses to figure their tax quickly and easily, without an accountant, attorney or computer software. It would generate about as much revenue as the present system, to avoid a wrenching reduction of government spending all at once -- or at all, depending on your preference. But it would save Americans and their government the billions of dollars spent each year on tax planning, preparation of complex returns, audits and prosecution.
What's fair?
You would strive for fairness in your simplified new system, but you would quickly discover that the perception of fairness is entirely subjective. Some folks think that progressive taxation -- higher tax rates on higher amounts of income -- is the essence of fairness. But others believe fairness means taxing every dollar at the same rate. Maybe you believe that income from different sources should be taxed at the same rate. But others believe that investment income should be taxed at a higher -- or lower -- rate than income earned in wages and salaries.
To some people, a fair tax code is full of incentives for behavior that they believe to be socially desirable: getting married, having children, owning a home, giving to charity, investing, saving for retirement. Ditto for businesses: incentives to buy new equipment, hire more employees, drill for oil, pay for health insurance. Whatever.
But other folks believe that a fair tax code lets people and firms spend their money as they please. Therefore all tax deductions, however well-intentioned, should be abolished.
Some ambitious reformers think the income tax should be replaced by (or reduced and supplemented by) a national retail-sales tax collected by merchants. This would stimulate saving by taxing only consumption. The burden on the poor and middle class could be eased by rebating some of the sales tax or by exempting food, clothing and medicine.
Others prefer a European-style value-added tax (VAT), which would be levied on goods and services at every stage of production and folded into final prices. In a growing economy, the VAT would raise prodigious amounts of money in a way almost invisible to tax-paying voters -- appealing to some members of Congress but appalling to others.
An American flat tax of 16% or 17% could be coupled with a high standard deduction that would exempt all low-income folks, and millions of lower-middle- income households, from paying any federal tax. But if Congress waffled on abolishing all itemized deductions -- including the wildly popular breaks for mortgage interest and charitable giving -- the flat rate would probably have to be in the mid 20% range to generate today's level of revenue.
Ironically, conservatives diminish the chances of their preferred reform, the flat tax, each time they persuade Congress to cut taxes within our present code. Example: the new 15% rate on dividends.
You've probably figured out by now why most Americans see sweeping tax reform as a fine idea in principle, but don't agree on which reform to embrace.
Scary implications
In assessing the prospects of sweeping tax reform, remember that just 25 years ago, top marginal rates of 70% and higher were common throughout the Western democracies. Those rates have been cut in half -- a remarkable political feat. But the next big tax-reform ideas -- the flat tax, national sales tax and VAT -- are vastly bolder, and scarier in their economic implications, than the rate cuts of the 1980s. So, merits aside, the odds of enactment are very slim. Most Americans seem to prefer the devil they know to the devil they can only imagine.
Columnist Knight Kiplinger is editor in chief of this magazine and of The Kiplinger Letter and Kiplinger.com.
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