Monday, April 15, 2013

The World's Biggest Cocktail Napkin

Note: My ideas on this subject are heavily influenced by CoyoteBlog and Asymmetrical Information

I want to be able to do my taxes on a cocktail napkin. Income tax complexity is a burden on all of us, and it provides opportunities for taxpayers and politicians to game the system. I want the income tax system to be as simple as possible. What I'm proposing is not as simple as possible, but it's a place to start that doesn't make me sound too bat-shit crazy. Here’s the short version of the plan:

1)   Treat all types of income the same.
2)   Eliminate all deductions and credits.

A few details on each of these:

1a)   No long-term capital gains vs short-term capital gains. No special categories of income at all. If I had income, it goes into the pile to be taxed. It's all subject to the progressive income tax scale we have now. I don’t care about the source of the income, it’s all counted the same.

1b)   We still have to allow capital losses to offset capital gains. If I make $100K from stock sales, but I also lost $60K from stock sales in the same year, I'm only net ahead $40K. That $40K is my taxable income. I haven't thought this through enough to think about whether to allow multi-year carry over on losses. Trying to fit this on a cocktail napkin, so I’d like to say no carry-over.

1c)   I'm a undecided on what to do about income from inheritance. My "keep-it-simple-stupid" guideline says to tax it as well. If my long lost uncle bequeaths me $100K, then that's $100K of income for me. But many many people have a strong sense of wanting to be able to give money (that was already taxed when they earned it) to their surviving relatives. I punt on this.

2a)   I'm serious about eliminating all deductions and credits. No charitable deduction. No home mortgage interest deduction. No deductions for educational or medical expenses. No earned income credits, no child/dependent credits. Nothing. The tax code is sneaky place place to reward certain types of behavior or conditions like having a mortgage, buying a Prius or Tesla, living through a disaster, or giving money to charity. If you want to encourage some behavior or assist some group of people with money, hand out money directly! Do not use the tax code to hide it. Shifting these programs out of the tax code will spare us the added complexity at tax time.

2b)   There should probably be some adjustment at the bottom of the tax brackets to replace the standard individual deduction we have now. Maybe make the first $10-30K or so of income tax-free. That's easy. Just tax the bottom bracket at 0%.

One last point. I suspect this plan would increase revenue. I know I would have payed more in taxes under this system than I did the last few years. If it helped get people on board with this idea, the tax rates could be adjusted to make this revenue neutral overall. But that isn't the primary goal. Let's gut the tax code first, then we can argue about the correct rates without all the distortions.