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Suggested Reforms of the Personal Income Tax
Raymond Richman, 7/19/2017

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:

  1. Place Ceiling on Personal Deductions. There should be a ceiling placed on total personal deductions, other than deductions for dependents. We would recommend a ceiling of 20% of gross taxable income instead of the $100,000-$200,000 recommended by some advocates.. The purpose of such a provision is to deny the very wealthy the ability to reduce their personal income tax liability by deducting gifts made from their accumulated wealth and to disincentive establishing private charities which pay salaries to relatives and cronies.
  2. End Deduction of Health Insurance Premiums. Employer-paid health insurance premiums should be included in employee gross income. They are deducted as a business expense by the employee and self-employed taxpayers and are a form of earnings paid to employees. Alternatively, allow the deduction of all health insurance premiums paid by households out of their own incomes. The latter would be more attractive to the Congress.
  3. Eliminate percentage depletion allowances or restrict them to the cost of newly built physical assets. Under percentage depletion, taxpayers deduct a percentage of gross income from mineral production and the deduction bears no relation to the construction of physical assets.
  4. Eliminate all wind, solar, and other energy tax credits. Subsidies do not belong in the tax code but in the budget where taxpayers can see how much the subsidy is costing them. This applies as well to hybrid and electric-powered vehicles, home insulation, and so-on.
  5. End Special Treatment of Capital gains on the sale of Homes and Securities. They should not be taxed at all if the proceeds are reinvested in similar properties.
  6. End Double Depreciation of Assets. When depreciable property is sold, the buyer should take the seller’s basis for depreciation. Hotels, office buildings, and other commercial real estate are depreciated over and over again because the purchase price becomes the basis for a new depreciation schedule. Accelerated depreciation is allowed to stimulate investment but it is often abused by the seller who has an incentive under current law to sell the depreciable property as soon as he has taken most of his depreciation allowance.
  7. End the Alternative Minimum Tax. The alternative minimum tax, originally expected to apply to a very small number of taxpayers when in was imposed in 1969 ended up affecting several million.
  8. Tax Corporate Income as Personal Income. Another major reform involves the abolition of the corporate income tax with individual taxpayers paying personal income tax on their shares of corporate earnings. Taxpayers would include their shares of corporate earnings in their personal taxable income. Corporations would withhold personal income tax on their earnings as we have indicated in an earlier article which would be the personal income taxpayer. The major argument favoring the abolition of the corporate income tax is that corporation do not bear the burden of the corporate income tax, individuals do as owners or customers, as we have argued in an American Thinker piece (June 17, 2017).

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.

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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. ( )

Response to this comment by , 8/4/2017:
I fully agree with your comment including indexing for inflation. The only difference I may have with your views is that after indexing, if the asset is sold and a capital gain realized, I would tax it as income unless it were rolled over into another income-yielding asset. Thanks for your comment.   Raymond Richman, 

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]