Arkady
President
A conversation in a thread below got me thinking about what I'd want the tax code to look like, if it were my call. Here's a first try, based on the system that was in place in 1955. Essentially, I just took the 1955 tax brackets for "married filing jointly," adjusted for inflation, and then subtracted 10 points from each tax rate (e.g., the lowest bracket used to be 20%, and in my code it's 10%).
The idea would be to have something close to the simplicity of a flat tax. You just plug in your total income, and you know your tax liability. There'd be a single tax only (SS and Medicare would be funded out of the same stream). Capital gains would be indexed to inflation then treated as ordinary income, and dividends would be ordinary income, too. Gifts and inheritences would also be ordinary income, but after small exemption in each case (the gift tax exemption being big enough to cover ordinary gifts like a grandparent giving a grandkid a used car, etc., and the inheritence tax exemption would be high enough to exempt a median home plus the value of median personal effects, with a little buffer, so that most people don't have to worry about it).
Here are the brackets:
Marginal
Tax Rate Over But Not Over
10.00% 0.00 33,763.82
12.00% 33,763.82 67,527.65
16.00% 67,527.65 101,291.47
20.00% 101,291.47 135,055.29
24.00% 135,055.29 168,819.12
28.00% 168,819.12 202,582.94
33.00% 202,582.94 236,346.76
37.00% 236,346.76 270,110.59
40.00% 270,110.59 303,874.41
43.00% 303,874.41 337,638.24
46.00% 337,638.24 371,402.06
49.00% 371,402.06 438,929.71
52.00% 438,929.71 540,221.18
55.00% 540,221.18 641,512.65
59.00% 641,512.65 742,804.12
62.00% 742,804.12 844,095.59
65.00% 844,095.59 1,012,914.71
68.00% 1,012,914.71 1,181,733.82
71.00% 1,181,733.82 1,350,552.94
74.00% 1,350,552.94 1,519,372.06
77.00% 1,519,372.06 1,688,191.18
79.00% 1,688,191.18 2,532,286.76
80.00% 2,532,286.76 3,376,382.35
81.00% 3,376,382.35 -
Here's the effective tax rate under that system, versus the effective tax rate under our current system, for the average income within each quintile and higher percentages:
Current system
Lowest quintile: $18,400 2.0%
Second quintile: $42,500 9.1%
Third quintile: $64,500 12.7%
Fourth quintile: $94,100 15.7%
Fifth quintile: $264,700 20.1%
Top 10%: $394, 500 20.7%
Top 5%: $611,200 20.9%
Top 1: $1,873,000 20.6%
Proposed system
Lowest quintile: $18,400 10.0%
Second quintile: $42,500 10.41%
Third quintile: $64,500 10.95%
Fourth quintile: $94,100 12.41%
Fifth quintile: $264,700 22.20%
Top 10%: $394, 500 29.32%
Top 5%: $611,200 37.49%
Top 1: $1,873,000 59.46%
Disadvantages of this proposal:
First, it's a huge decrease in after-tax income for the poorest quintile, and a meaningful decrease for the second quintile, so it would need to be accompanied by more generous social benefits, to remove some cost for such people, or they'd really be in bad shape. However, the overall revenues would be considerably higher, so that would be affordable. Also, the rates get pretty steep at the top-end (albeit nowhere near where they were in the 1950s), so there's some risk you'd cause excessive distortions in the market.
Advantages of this proposal: Middle-class taxes decline. A simpler tax scheme makes doing your taxes something that would only take a few seconds (or a few minutes if you have capital gains). Revenues go up. There is less distortion from people trying to reclassify earnings to take advantage of low taxes for privileged income streams like dividends.
What appeals to me most about it is its consistency. It starts with the notion that effective tax rates should rise as you go up the ladder, and it sticks to that. Every level pays higher effective tax rates than the level below it (something that breaks down at the top level in our current system), and there's no plateauing effect within that top quintile (whereas today those earning a quarter of a million dollars per year pay almost the exact same effective tax rate as those earning seven times as much as them).
Another way to think about this is how big the advantage would be, in after-tax income, for moving up within the income distribution. So, for example, in the current system, moving up from an average bottom-quintile salary to an average second-quintile salary takes you from $18,032.00 of after-tax income to $38,632.50 in after tax income, which is a 114.24% increase. Here's the percentage gain in after-tax income for moving up from the next-lower tier in the current system (first percentage) and the proposed system (second percentage):
Second quintile: 114%, 130%
Third quintile: 46%, 51%
Fourth quintile: 41%, 43%
Fifth quintile: 167%, 150%
Top 10%: 48%, 35%
Top 5%: 55%, 37%
Top 1%: 208%, 99%
As you can see, the current system creates gigantic incentives to climb up those last few rungs of the ladder. The payoff, in percentage after-tax income increase, for moving ahead of just 5 percent of the population, from the 10th percentile to the 5th, is greater, under the current system, then the payoff for moving past a full 20 percent of the population, by moving from the second to the third quintile, or from the third to the fourth. And the reward for moving past just 4% of the population, from the 95th percentile to the 99th, is twice as great as the reward for moving past 40% of the population, by moving from the second quintile to the fourth.
By comparison, the modified system provides stronger incentives towards the bottom end. There's a huge payoff for moving up from the first quintile to the second, and a decent one for moving from the second to the third quintile, and the third to the fourth. The incentives at the top end are still extremely good, but no longer as overwhelmingly so. The idea here is that you want people at every level to have a good incentive for working to move ahead, rather than squandering excessive incentives at the top. My system should be particularly good at incentivizing people to rise off the bottom rung, given the huge after-tax reward for that.
Thoughts? Alternatives?
The idea would be to have something close to the simplicity of a flat tax. You just plug in your total income, and you know your tax liability. There'd be a single tax only (SS and Medicare would be funded out of the same stream). Capital gains would be indexed to inflation then treated as ordinary income, and dividends would be ordinary income, too. Gifts and inheritences would also be ordinary income, but after small exemption in each case (the gift tax exemption being big enough to cover ordinary gifts like a grandparent giving a grandkid a used car, etc., and the inheritence tax exemption would be high enough to exempt a median home plus the value of median personal effects, with a little buffer, so that most people don't have to worry about it).
Here are the brackets:
Marginal
Tax Rate Over But Not Over
10.00% 0.00 33,763.82
12.00% 33,763.82 67,527.65
16.00% 67,527.65 101,291.47
20.00% 101,291.47 135,055.29
24.00% 135,055.29 168,819.12
28.00% 168,819.12 202,582.94
33.00% 202,582.94 236,346.76
37.00% 236,346.76 270,110.59
40.00% 270,110.59 303,874.41
43.00% 303,874.41 337,638.24
46.00% 337,638.24 371,402.06
49.00% 371,402.06 438,929.71
52.00% 438,929.71 540,221.18
55.00% 540,221.18 641,512.65
59.00% 641,512.65 742,804.12
62.00% 742,804.12 844,095.59
65.00% 844,095.59 1,012,914.71
68.00% 1,012,914.71 1,181,733.82
71.00% 1,181,733.82 1,350,552.94
74.00% 1,350,552.94 1,519,372.06
77.00% 1,519,372.06 1,688,191.18
79.00% 1,688,191.18 2,532,286.76
80.00% 2,532,286.76 3,376,382.35
81.00% 3,376,382.35 -
Here's the effective tax rate under that system, versus the effective tax rate under our current system, for the average income within each quintile and higher percentages:
Current system
Lowest quintile: $18,400 2.0%
Second quintile: $42,500 9.1%
Third quintile: $64,500 12.7%
Fourth quintile: $94,100 15.7%
Fifth quintile: $264,700 20.1%
Top 10%: $394, 500 20.7%
Top 5%: $611,200 20.9%
Top 1: $1,873,000 20.6%
Proposed system
Lowest quintile: $18,400 10.0%
Second quintile: $42,500 10.41%
Third quintile: $64,500 10.95%
Fourth quintile: $94,100 12.41%
Fifth quintile: $264,700 22.20%
Top 10%: $394, 500 29.32%
Top 5%: $611,200 37.49%
Top 1: $1,873,000 59.46%
Disadvantages of this proposal:
First, it's a huge decrease in after-tax income for the poorest quintile, and a meaningful decrease for the second quintile, so it would need to be accompanied by more generous social benefits, to remove some cost for such people, or they'd really be in bad shape. However, the overall revenues would be considerably higher, so that would be affordable. Also, the rates get pretty steep at the top-end (albeit nowhere near where they were in the 1950s), so there's some risk you'd cause excessive distortions in the market.
Advantages of this proposal: Middle-class taxes decline. A simpler tax scheme makes doing your taxes something that would only take a few seconds (or a few minutes if you have capital gains). Revenues go up. There is less distortion from people trying to reclassify earnings to take advantage of low taxes for privileged income streams like dividends.
What appeals to me most about it is its consistency. It starts with the notion that effective tax rates should rise as you go up the ladder, and it sticks to that. Every level pays higher effective tax rates than the level below it (something that breaks down at the top level in our current system), and there's no plateauing effect within that top quintile (whereas today those earning a quarter of a million dollars per year pay almost the exact same effective tax rate as those earning seven times as much as them).
Another way to think about this is how big the advantage would be, in after-tax income, for moving up within the income distribution. So, for example, in the current system, moving up from an average bottom-quintile salary to an average second-quintile salary takes you from $18,032.00 of after-tax income to $38,632.50 in after tax income, which is a 114.24% increase. Here's the percentage gain in after-tax income for moving up from the next-lower tier in the current system (first percentage) and the proposed system (second percentage):
Second quintile: 114%, 130%
Third quintile: 46%, 51%
Fourth quintile: 41%, 43%
Fifth quintile: 167%, 150%
Top 10%: 48%, 35%
Top 5%: 55%, 37%
Top 1%: 208%, 99%
As you can see, the current system creates gigantic incentives to climb up those last few rungs of the ladder. The payoff, in percentage after-tax income increase, for moving ahead of just 5 percent of the population, from the 10th percentile to the 5th, is greater, under the current system, then the payoff for moving past a full 20 percent of the population, by moving from the second to the third quintile, or from the third to the fourth. And the reward for moving past just 4% of the population, from the 95th percentile to the 99th, is twice as great as the reward for moving past 40% of the population, by moving from the second quintile to the fourth.
By comparison, the modified system provides stronger incentives towards the bottom end. There's a huge payoff for moving up from the first quintile to the second, and a decent one for moving from the second to the third quintile, and the third to the fourth. The incentives at the top end are still extremely good, but no longer as overwhelmingly so. The idea here is that you want people at every level to have a good incentive for working to move ahead, rather than squandering excessive incentives at the top. My system should be particularly good at incentivizing people to rise off the bottom rung, given the huge after-tax reward for that.
Thoughts? Alternatives?
