Taxes

I finished doing my taxes yesterday. It was easier than I expected, although I ought to file an amended return for the state of Kansas. As a part year resident, I have the choice of either filing as a resident or a non-resident. The state recommends figuring out what you owe both ways, and then filing with the status in which you are better off. I started by figuring out what I would owe if I filed as a resident, but then just submitted that without redoing it as a non-resident. I'm pretty sure that means I paid more than I needed to (I only earned a paycheck in Kansas for 2 months), so I'll probably take another look at that.

A friend of mine from college, Jon, after completing his 2007 return pondered how things would change for him if Mike Huckabee's flat tax plan were implemented. Jon runs his own company, so I'm sure his taxes are much more complex than mine. One of the things that was appealing to him was the simplicity of a national sales tax. I don't blame him for that after he and his wife spent something like 27 hours working on their return.

I decided to figure out what I would have paid in taxes under the national sales tax. Since Huckabee has said that his plan would be revenue neutral, it means that a federal sales tax would be around 32%. I took my gross income, subtracted my savings and investments, to get a rough estimate of what I spent in 2007. I multiplied that number by 32% and then subtracted the prebate that fairtax.org, a national sales tax advocacy organization, recommends for someone of my income level. The total was about 3.3 times as much as I paid in taxes under the current system.

My understanding of a national sales tax like Huckabee advocated is that people at the top and the bottom of the income scale would pay less in taxes, while most of the country would pay more. That would certainly be the case for me.

Of course, the main objective in a federal tax code is to raise enough money for the federal government to operate, but other goals include crafting the code to ensure compliance (which often means making it simple) and to ensure that it impacts the country in a just manner. Those last two goals often work at cross purposes. If you make the tax code simple, like a national sales tax would, it treats everyone the same. I think it would be more just to expect those who have derived the greatest benefit from our society to contribute more, not less, to the costs of maintaining and improving the country. The more progressive a tax system is, however, it becomes more complex.

Right now hedge fund managers are able to classify most of their compensation as capital gains rather than wages. This means they pay at the 15% capital gains rate rather than the 35% income tax rate which would normally apply. Not surprisingly, they have fought an effort in Congress to reclassify their wages so that they pay a similar amount as other's who earn similar amounts of money. That change would make the tax code more just, I believe, but also slightly more complex.

Another danger of the national sales tax is the effect it would have on local and state governments who current rely on sales taxes. The sales tax where I live is 7.8%, so when I purchase an item that costs $100, with a national sales tax I have to hand over $139.80! Of course, all of the local and state governments would have to change their tax structure because the lure of under-the-table transactions would too high at almost 40%. Most economists believe that about 10% is the maximum sales tax rate you can set before the underground economy really starts to grow. So the governments who already have a sales tax would need to change to something like an income tax, or rely more heavily on property taxes.

All forms of taxation have some economic distorting factors. An income tax with no capital gains tax, or AMT, hits only those who primarily earn money from a paycheck, while the wealthiest Americans would get by without paying hardly any federal tax. A sales tax hits those who spend almost all of their income much harder than those who earn enough that they have other uses for their income. Property taxes are a way to capture the wealth in real estate that many accumulate, but is extremely harsh towards those on fixed incomes who paid off their mortgages years ago (Since property taxes are a prime way we fund schools, the quality of a school is often directly tied to the wealth of the neighborhood in which it sits - so the kids from poor neighborhoods who likely need the most support from their school, end up attending schools that are crowded, struggle to maintain their physical plants, and have teachers at the bottom of the income scale)

I think it is for the best to have a variety of different kinds of taxes, rather than relying on any one scheme. It makes for a more complex tax code, but the various distortions have a chance of balancing each other out. And that's probably more of my thoughts about taxes than anyone wants to read on my blog!