Income tax

I e-filed my income tax this year. The process was relatively painless compared to previous years where they wanted to charge you a premium to make the data entry for the government easier. I refuse to pay $20 for the privilege of filing on line. It was free with my tax software this year, so I was happy to use it. I hope my meager refund is deposited to my checking account without additional excitement.

Not that I am enthusiastic about paying income tax. I am not enthusiastic about paying taxes in general. But I realize that taxes are necessary to fund essential services from the government. That creates a debate on two ends: the paying end and the spending (budget) end.

Consider the paying end first. My main concern about paying taxes is that I pay my fair share. This is not the day for me to argue about government waste and frivolous spending. The overhead in a democracy is that I end up paying for a service that someone else claims is essential, but that I believe is frivolous. That's why the discussion of government waste often begs the question: why is it waste if it has a constituency? Many of the richest people in the country have made their millions from government programs that many of us might call waste. How narrow minded of us call wealth production waste.

But that's not taxes, that's budget. I'll save the discussion about the budget for a later blog...

As an aside, I respect Warren Buffett. I especially respect his remark that no tax system was fair if it taxed Mr. Buffett's secretary at 30% of her compensation, but only demanded 17% from Mr. Buffett. The other reason I admire Mr. Buffett is not because he is one of the richest men in the world, but because he has become rich while maintaining a modest life style and an annual salary of $100,000, for the last 25 years. I contrast this to the myriad less talented CEO's who have helped to plunge this country into economic ruin while stealing value from their shareholders. We would all be in better shape if our leaders were like Mr. Buffett. Then we might have leaders worth emulating.

Back to paying taxes.

I am not going to get bogged in state and local taxes, although I believe that sales taxes are unfair to our poorer citizens, and probably property taxes, too. I'm going to focus on the call for a national flat tax to "simplify" the tax code and put us "all" on equal footing.

The first queston you should ask about a tax is not what is the tax rate? The first queston you should ask is "What is being taxed, and how much will I pay?"

On the one hand, income tax is based on adjusted gross income. Adjusted gross income does not include capital gains. AGI does not include the deductions allowed by congress. On the other hand, Social Security tax is based on the first 80 or 90 thousand dollars of earned income without regard to any adjustments (again, capital gains are not earned income).

Now for the third hand:

Let's just assume that your senator is trying to persuade you that a flat tax would be good for you while being simpler to calculate. Does he allow for any adjustments in income? Do you get deductions for yourself and your children How about medical expenses? Isn't this where much of the difficulty in doing taxes arises? But do you want to give up these deductions? If the answer is no, we don't have to proceed. If the answer is yes, we can continue the discussion.

What about captial gains and other forms of "income" enjoyed by the wealthy but not taxed as ordinary income? They are not salary. They already have a flat tax rate. Should they be merged with earned income?

If you are salaried, the process to establish your income may be straight forward, but self employed people and executives have accountants that can label many of the benefits they receive as something other than income. How do you count that money to make it fair for people without those stealth benefits. Well, let's assume we can, and continue onward.

So now we adopt a flat federal tax on everyone's "transparent income." Wait! Does that include Social Security. Every congressman that I have seen propose a flat tax, responds that no, there should only be a flat rate for income tax; a flat tax for social security would not be fair.

So if you make $50,000 under the 10% flat tax for income tax, your federal tax would $5000 to the IRS, and $3825 Social security and medicare ($7650 if you are self employed) for a total bill federal bill of $8825 ($12825 if self employed). Your effective tax rate is 17.65% (25.65% if you are self employed.) (Note that Capital gains were recently taxed at 15%). Local and state income tax, sales tax and property tax can easily push your total tax liability to 30%.

Now compare this to someone making $300,000. The flat tax charges them $30,000 for the IRS, and Social security extracts the $6621.60 max ($13243.20 if self employed) plus $4350 for medicare. The total federal tax bill is $40,971.60 ($47,593.20 is self employed). The effective tax rate is 13.66% (15.86% if self employed).

If you are fortunate enough to have a salary of $1,000,000, your 10% flat rate income tax is $100,000, social security remains at $6621.60 max ($13243.20 if self employed) plus $14,500 in medicare. Your total federal tax liability if $121,121.60 ($127,743.20 if self employed) with an effective tax rate of 12.12% (or 12.77% if self employed).

The only upside I can see in this scheme is that the rich will demand to pay captial gains at their ordinary income rates, something they have fought for years.

Would wealthy people be willing to give up their deductions and accountants to make income transparent so that a flat tax might work? Wouldn't that be equivalent to giving up privilege? Would federal taxes truly be a flat tax if social security and medicare are not included in the equation?

I have seen many claims that the wealthiest 5% in the coutry pay 70% of the income taxes, usually followed with a claim that this is not fair, it is class warfare, and it soaks the rich. But if those numbers are correct, how do they relate to a claim I have seen that the top 5% also own 90% of the country's wealth? It seems to me that whoever owns 90% of the nation's wealth should pay 90% (not 70%) of the nation's taxes. That's not a soaking, that is equity. Since the federal income tax was established, the wealthy have managed to convince the masses that the economy would suffer if the wealthy were distracted from investing by paying taxes like commoners. The same doom and gloom arguments are being resurrected now with the current administration talking about returning to the Clinton years tax rates on income over $300,000 (boom years as I recall).

There are lots of people to fault over the current economic crisis. Many of them homeowners who chomped off more than they could chew. But I lay the most egregious damage at the hands of CEOs, Bankers and Politicians whose unrestrained greed for astronomical income shifted the center of gravity from the hold where most of us work the ship up to the captain's quarters. Top heavy ships tip over, and the more grievous the weight shift, the smaller the righting angle.

Look at what's printed on our money: The United States of America. Individuals do not mint the money they amass , and it is the economy supported by us all that allowed the rich to achieve wealth. Now is the time for those who benefited the most from the unregulated economy to contribute their fare share to steady the ship for safer sailing.