By Steve Gillman

In part one of this series, we looked at whether our tax system is really progressive, and in part two we looked whether it should be. Today I wrap it up with some ideas on a fair tax system. The term “fair tax” has been unfortunately co-opted by those who advocate a national sales tax as a replacement for the income tax system. It actually does not seem too fair to me.

In it’s simplest form a sales tax is the most regressive tax possible. It shifts much of the tax burden to the poor and middle class, since they spend a larger percentage of income on taxable items. Most proponents call for a rebate or “prebate” based on income as a way to solve this problem, but there are other real problems with a sales tax.

Advocates tend to pick their examples carefully in arguing for the tax, but alternative examples are easy to find. For example, they will say that the wealthy who live by drawing on capital gains for expenditures pay just 15% of that income as taxes now, and so would pay more if there was a 23% sales tax. But it is easier to imagine a man who makes $200 million, and who spends just $10 million on retail purchases, paying just $2.3 million under this system, rather than the minimum of $30 million he would have to pay now. There are other issues with this so-called “fair tax” that I won’t get into here.

My alternative? I preferred a flat tax at one time (which, as explained previously is actually progressive in effect), and was even attracted to the idea of a national sales tax–before I understood the inherent problems with it. Now I like the idea of a simplified progressive income tax system.

My suggested rates: 1% on income up to the poverty level for a couple, 10% from there up to the average per capita income for the U.S., and 30% from that point upward. Since taking 20% out of the current GDP in taxes would more than cover the budget needs of the reduced expenditures I favor (I believe the current percentage is 25%), and since there are other sources of taxes (excise, corporate, etc), this would provide more than enough funding for government.

All deductions would be eliminated–even for dependents–but that’s better explained at another time (although I will note that I don’t care for a system that subsidizes over-population). Social security taxes would also be eliminated–something which is also better explained elsewhere. The poverty level and the average per-capita GDP would be computed carefully each year in order to implement the income tax.

Notice the shift here. At the moment, a single woman who makes $10,000 working part time pays $1,540 in payroll taxes (Social Security and Medicare). Under the system suggested she would pay just $100. Currently a childless couple who make $94,000 from their small business, pays about $24,000 in total federal taxes (income, Social Security, and Medicare). Under the proposed system, they would pay about $17,500.

Corporations would pay at the top rate of 30%, which is below the current rate of 35%–but above the current average of about 15% after credits and special deductions. The wealthy would pay no more than 30%, also lower than the current top rate of 35%. Despite this, it is those making more than $200,000 who will pay more overall, even at the lower rates. This is due to the lack of tax shelters and greater enforcement of tax law that would be a part of this system.

This system would be progressive and would easily pay the bills. What’s more worthy of note here is that it provides an opportunity for all those who are poor or below the average income to become wealthier. A small business owner making $40,000 currently pays 15.4% of his income in self-employment tax (Social Security and Medicare) on top of the income tax he pays. He might currently pay out 25% to 30% of his total income to the federal government, or about $10,000 to $12,000. Under the new system he would pay about $2,650 (assuming poverty level is about $15,000), or just 6.6% of total income.

This provides opportunity to reinvest in a business and motivation to work harder, since he gets to keep more of what he makes. A predictable system that taxes reasonably would not discourage the risk-taking of entrepreneurs, nor would it stop investment–even if capital gains were taxed as ordinary income. In fact, history and comparative looks at various systems show that predictability is almost as important as the rate of taxation until you get to higher levels. Businesses and investors need to know how to plan and for that they need to know how they will be taxed.

The poor will be left largely free of taxes (at the federal level), although the nominal 1% rate keeps them in the system, which is good for society. This will allow for more rapid progression up the economic ladder, at which point they will pay more in taxes. Wealthier middle and lower classes will be good for all in society. I think this would be a relatively fair tax system. Whether you agree or disagree, you can leave your comments below.