Flat Tax, Fair Tax and U.S. Federal (Current) Tax System Comparison - Research Paper Example

 Flat Tax, Fair Tax and U.S. Federal (Current) Tax System Comparison Abstract The taxation system of any country is an essential part of the government and its politics. Considering the case of the U.S., it has been obtained that the country’s taxation system has led to several controversies over the years with the system being highly complicated and creating difficulties for the people of the country. Flat tax and fair tax are two alternatives that may be considered by the government of the country to improve the present state of the taxation system. the present study focuses on these different forms of the taxation systems and determines that considering the benefits and comparisons with each other, the fair tax would be the best for the country and its people. Introduction: The tax system in the United States is based upon both the federal and the state levels of taxation. The different types of taxes that are included in this system of taxation are sales, income, capital gains, among others. The taxes set at the federal level are different from that of the state level and hence the authorities for taking charge of these taxes are also different. There is no interference of one taxation system in the other. Thus each of the states in the U.S. has and follows their own tax systems which vary from the other states. The income tax involves reduction of certain amounts from the individual incomes that the countrymen earn in a year. On the other hand, the sales tax is charged on any purchases that individuals make (U.S. Taxation, n.d.). Statement of the Problem: This research study examines the different tax plans and then determines which plan would be most advantageous to the growth of the U.S. and its citizens. In the present times, closer attention is being paid by the citizens on how their tax payments are being utilized by the government and the justifications of the amounts that they are paying. Such attention has been obtained from certain level of awareness among the citizens. The U.S. has been borrowing money to fund its obligations and this is one of the big red flags that have caused many to look closer at our current tax system. The current tax code is not working effectively or efficiently and a reform or a change must be made to meet our needs. For this to be done, the U.S. must modify its current tax plan or change to another tax plan to ensure we are able to fund our budget while reducing the burden of the tax payer. It has been suggested that flat tax and fair tax are two alternative systems of taxation that can be implemented in the country intending to improve the taxation system of the country. The flat tax system allows same rates of tax to every taxpayer not considering their category of income (Flat Tax, 2013). The fair tax would involve replacing all the existing federal and corporate taxes with a federal retail sales tax of 23 percent to be governed by the authorities of sales tax that are existing in the state. “The sales tax would not apply to imports, goods used by businesses to produce other goods, or used goods” (Amadeo, 2013). The present study suggests that the fair tax would be the best alternative for the U.S. taxation system. Purpose of the Study: The purpose of this study is to learn about the different tax plans by reviewing the major aspects involved in each plan using evidence based research as a guide and then determining which tax plan is most advantageous for the U.S. The research questions include: What is the most effective and efficient tax plan that will benefit the government and the citizens of this nation? Is the income tax or the sales tax plan more beneficial for the Government and the tax payer? These questions are an integral part of this study. Literature Review: The federal tax system of the U.S. has been into existence over the last 40 years. There have been several changes in the system over these years that have led to decline in the improvement of the taxation system in the country. Firstly, the tax rates of the top marginal incomes of individuals have reflected significant decline over the years. During the 1960s, the legal individual income tax rate affected to the marginal dollar for individuals having the highest incomes was 91 percent. This percentage has now declined to 28 percent during the 1988s. The percentage showed significant increase in 1993 by around 39.6 percent and again decline to 35 percent in 2003. Secondly, decline has also been obtained in the corporate income taxes as a proportion of the gross domestic products. Almost half the percentage has fallen from 3.5-4.0 percent during the 1960s to around 2 percent during the 2000s. However, the profits of the corporate as a fraction of the GDP have not reflected any declines over the years. This suggests that the owners of the capital are gaining more of the net taxes in the present times unlike the situation in the 1960s. A third factor has been obtained with the increase in the financing of the payroll taxes. This also includes the factors like social security, retirement benefits, and Medicare. The payroll rates of tax for the combined employee and employer reflect an increase from 6 percent during the 1960s to around 15 percent during the 1990s and the 2000s (Piketty & Saez, 2007, p.3). Tax reform is a topic that has been a major issue of debate in the United States for several years. With the decline in the economy of the country, the government and the taxpayer have formed their own ideas and the methods to obtain a proper taxation system for the country. Some of them have focused on the increase in the taxes collected by government trying to help lessen the deficits in the budget and pay for public speculation. Others have focused on the reduction of budget deficits and pay for public investment by increasing taxes while others have also focused on encouraging economic growth by decreasing government taxation (Carbaugh & Ghosh, 2011, p. 61). Considering these factors, the primary concern for the country is to determine a taxation system that would enable obtaining these goals. Progressivity of the federal tax system in the U.S.: The three major changes that have been mentioned above have drastically affected the taxation system in the U.S. and hence affected its progressivity. For instance, considering the case of the individual income tax, the abundant deductions and exemptions reflect that the rates of taxes as provided in the list of the tax tables might be a deprived act of the real tax load encountered by every income group. Additionally, certain kinds of income, including the capital gains, have conventionally encountered lower rates of taxes; this has disproportionately benefitted the taxpayers who belong to the high-income group. Considering the case of the corporate income tax, there are opposing assumptions concerning who stands the trouble related to the tax: “for example, does it reduce returns for stockholders or reduce the returns on other assets such as bonds or pensions of future retirees; is it paid by workers in the form or lower wages or is it paid by consumers in the form of higher prices?” (Piketty & Saez, 2007, pp.3-4). The political interferences have largely affected the taxation system in the U.S. With the changing political scenario over the years, every time the politics have changes in the country, the progressivity of the federal taxation system of the country has been diminished. The regressivity of the Social Security tax system has also offset the progressivity of the federal taxation system in the country. The social security tax system is responsible for the collection of flat taxes on incomes that have been set up to a certain amount. Studies reveal that with the continuation of the current trend in the system, the federal personal tax system would completely cease away sooner and would not be progressive at all. “Whether it is sufficiently progressive even now to offset regressivity in state and local tax systems is not clear – state sales tax systems, for example, while usually exempting food, still apply a fixed rate on all other consumption goods and are thus regressive at higher income levels” (Schutz, 2011, p.181). Thus considering all these factors and the different taxes that are applicable at different levels of the government, researchers have obtained that the U.S. tax system “may be only mildly progressive, roughly neutral, or even regressive in its impact” by the level of personal income (Schutz, 2011, p.181). The major criticisms of the current tax plan is that it is too complex, confusing, that it is negatively impacting growth in the economy, and that it cannot be equally applied to all taxpayers. There are too many credits and deductions which only benefit certain people or businesses. Some wealthy people avoid paying taxes by using tax shelters and others illegally avoid paying taxes because they know the IRS does not have the resources to stop them (Jones, Thomas, & Lang, 2012, p. 5). Some benefit from the earned income credit illegally, and some use the credit as an income buffer, while those are who work hard does not qualify for this credit. Graetz said “The earned income tax credit supplies indispensable wage subsidies to low-income workers and their children, but it is not working well. The IRS estimated in 2002 that almost one-half of these credits are being claimed by people not entitled to them, at a cost of $11 billion a year. Moreover, the vast majority of workers entitled to the EITC receive their credit as a lumpsum refund after they file their tax returns” (p. 290). Tax Progressivity: The conventional explanation of tax progressivity developed from the perception of upright equity, a major consideration that was taken concern of in tax policy.1 “Vertical equity in tax policy requires that the tax liability of an individual, household, or tax unit increase as the income of that individual, household, or tax unit increases” (Clemens, Veldhuis & Murphy, 2013, p.1). This conception has developed into a standard in tax system and has been named as progressivity, which entails “not only that the tax liability (amount owed) increase as income increases, but that it increase in greater proportion to the tax than to the increase in income” (Clemens, Veldhuis & Murphy, 2013, p.1). It can thus be said that by means of progressivity higher-income individuals, households, or tax units are required to pay a considerably greater share of their income in taxes such that the value of the dollar of the tax liability increases with increase in income, as well as increasing the percentage of income used by taxes (Clemens, Veldhuis & Murphy, 2013, p.1). With the new definition of progressivity in place, two groups are largely considered as part of the system: the tax payers and the tax takers. In simpler terms, a much larger group of prospective tax payers are excused from paying the major taxes “to the point of having no tax liability in contrast to another group, largely composed of upper-middle-income and high-income households that contribute well beyond their proportionate share of income” (Clemens, Veldhuis & Murphy, 2013, p.1). This difference has severe consequences for a democratic system and the capability of citizens to build cooperative decisions through government. It is this final contemplation, specifically the association between contributions of the taxes and autonomous decision-making that has gone fundamentally ignored (Clemens, Veldhuis & Murphy, 2013, pp.1-2). The truth is that there is a primary disparity for general public in democratic states in building communal decisions “when there is a direct cost to them in the form of additional fees, taxes, or other levies compared to circumstances where here is no direct cost; indeed, in many cases there is almost no cost whatsoever” (Clemens, Veldhuis & Murphy, 2013, pp.1-2). Putting it in a simpler way, the general public makes diverse resolutions when they are encountered with the outlay, although they might be only fractional costs, of the choice. The latest promising explanation of progressivity, which is not merely theoretical but an observable fact of the present times that is “being put into place in many countries including Canada and the United States fundamentally alters the democratic decision-making process” (Clemens, Veldhuis & Murphy, 2013, pp.1-2). Fair Tax and Flat Tax: With the federal taxation system in practice, there are several controversies in regard to the payments not being done in a fair manner by the income individuals and other income groups. Flat tax came into existence since the year 1981 (Hall & Rabushka, 2007, p.24). Flat tax is in general not considered to be suitable for a country like U.S. since the different states in the country generally follow different taxes on different commodities and they vary in their decisions and payments of taxes. Thus a single sales taxation system may not prove to be suitable for the country. With the initiation of the sales tax, the evasion of the taxes is expected to increase (Forbes, 2005, p.85). Retailers are put in an unfair position if the flat tax is being followed. The cost of the government would also rise with the flat tax system in place. Also, there can be expected several political obstacles to this system of taxation in the country. Since there are all these drawbacks, the national sales tax system is not supported by the nation or the politicians (Forbes, 2005, pp.85-86). Thus there are significant debates in regard to the use of the flat tax system in the country. Flat tax systems have been obtained to be unreasonable since they take for granted that everybody has the similar capability to pay a definite rate of tax. However it is of major concern that individuals with a lower income would not be able to pay in the manner individuals with higher income would be capable to pay the taxes. “Flat tax systems are either unsustainable because they would ask for a less amount than what the country needs, or would be unfair to those who make less because the amount demanded would not support their lifestyle” (Is a flat tax system better than a progressive tax? 2013). Thus the flat tax system does not consider the difference and the effects of difference in incomes among the rich and the poor that might lead to huge suffering for the lower income groups of people. The flat tax system makes the taxation system equal for all.  A flat tax would penalize the poor for the reason that the percentage of tax corresponds to much more of their working income. “For example, if you make $100 and there is a flat tax of 30%, that leaves you with only $70 for living expenses. If you make $1000, the flat tax leaves you $700 for living expenses” (Is a flat tax system better than a progressive tax? 2013). It is obvious that the person that belongs to a higher income group is not as affected by the tax because since they would have much left even after paying the taxes. “This makes the poor poorer and the rich richer. Taxes should be progressive, charging more to the richer and less to the poorer” (Is a flat tax system better than a progressive tax? 2013). Frauds have been studied through the decisions planned on flat tax system. One of such frauds is as follows: In the U.S. Senate, a flat tax of 20 percent was proposed by Arlen Specter, on the income earned by people, from which the unearned income of the rich people that include their capital gains, interest and dividends, would be excused. Similar legislation was supported by the Congressman Dick Armey in the House. “Former presidential candidate Steve Forbes made as a centerpiece of his failed campaigns a flat tax scheme that salutes the idle rich by exempting UNEARNED income gained as a return on investment. Since Forbes' plan reduces taxes on the poorest and especially favors the wealthy, but is supposed to be revenue-neutral once again it means the middle class working people would be the ones squeezed to make up for benefits to the rich” (Dunn, 2006). On the contrary, a fair tax replaces all the federal taxes including the personal income tax, the corporate income tax, the estate and gift tax, the capital gains, the alternative minimum, the Social Security, the Medicare, as well as the self-employment taxes with a federal retail sales tax that is charged once only at the time of purchase on goods and services that are new for the individual (Kuang, 2008, p.4). The most important benefit of the implementation of the fair tax is the elimination of the income tax. With this system in practice, there would no more be the existence of the IRS thus enabling accountants to do something better. Also, since the taxes would be paid at the time of the purchase, hence there would not be any chance of screwing up one’s tax charges or responsibilities (Fair Tax: The Pros and Cons, 2009). With the fait tax system, the amounts of taxes that would be required to be paid would also be lesser. Payments of taxes would only be on the expenditures and not on the income thus satisfying the countrymen more than now. The fair tax system has also considered the existence of the poor. In the present times, the poor people either pay very less taxes or do not pay them at all since they struggle in meeting their day to day lives. With the fair tax system in place, this problem gets resolved for the poor as well (Fair Tax: The Pros and Cons, 2009). The benefits of the Fair Tax can be listed as follows: “Eliminate all federal personal income, gift, estate, capital gains, alternative minimum, earned income tax credit, Social Security, Medicare, self-employment, and corporate income taxes; Enable workers and retirees to receive 100% of their paychecks and pension benefits; Continue Social Security and Medicare benefits; only the means of collecting revenue to fund these programs changes; Rebate to households each month the federal sales tax paid on basic necessities up to a level of spending known as the poverty level (based only on the number of people in a household—not income—and set by the U.S. Department of Health and Human Services) which will remove the burden of federal taxation on the poor; Treat everyone the same with no deductions, exemptions, loopholes or interference by lobbyists; Collect federal sales tax from every consumer in the country, including citizens, foreign visitors, illegal aliens and those involved in the ‘underground economy’; Reveal to each individual the precise amount of tax being paid to the federal government; State the amount of national sales tax paid on every cash register receipt; Collect the national sales tax at the retail cash register, just as 45 states already do; Allow states the option of collecting the national retail sales tax, along with their state and local sales taxes (states and retailers will receive a fee for performing this service); Bring greater accountability, easier enforcement and visibility to federal tax collection; Set a “revenue neutral” federal sales tax rate; that is, a rate that raises the same amount of tax revenue collected now by the federal income tax system; Restore financial privacy to individuals and corporations by eliminating the need for any recordkeeping now required for the preparation and filing of federal income tax returns; Abolish the Internal Revenue Service and all audits of federal income tax returns; Eliminate the very high federal income tax compliance costs that are now imposed on businesses by the federal tax code and embedded in the retail prices consumers pay; Encourage saving and investing, thereby providing capital needed for creation of jobs and economic growth; Classify tuition as an investment in human capital rather than consumption, making education about half as expensive as it is now; Attract trillions of dollars of foreign equity investment to the United States, as well as encourage domestic firms to locate projects in the United States that might otherwise go abroad; and Repeal the 16th Amendment, through companion legislation; forbidding a federal income tax” (Fair Tax Benefits, n.d.). Research Methodology: The study has been based on qualitative research and has been used to determine the most beneficial tax plan for the U.S. and the taxpayer. Qualitative methods including secondary studies from the available secondary researches and studies have been used to evaluate the major aspects involved in each tax plan in order to determine the most advantageous plan for the country. Books, articles, journals and opinions and views of other researchers have been used to come to a conclusion on the topic of concern. The ethical values and credibility of sources have also been maintained effectively. Significance of the Study: This case is important because it has examined each tax plan in depth in order to determine the most beneficial tax plan. This research proposal helped to clarify the details of each plan and how they will impact the Government and the taxpayer. Findings and Analysis: Hypotheses: As part of this study, investigation included two research hypotheses: 1. The tax code is biased and the taxpayer is suffering increasing tax burdens under the current tax plan. 2. The Fair tax plan is the most beneficial tax plan to the Government and the taxpayer. Findings: The income and federal tax rate statistics can be studied from the information provided in the table below: Average tax rate (percent) Income Shares Income Groups Average Income (pre tax) Federal individual Payroll Federal corporate Federal estate and gift Total federal taxes Pre-tax income share Post-tax income share Full population (144 million tax units) $52,110 11.5 9.3 2.3 0.4 23.4 100.0 100.0 P20-40 $15,897 -3.2 10.6 2.0 0.0 9.4 6.1 7.2 P40-60 $29,870 3.2 11.2 1.7 0.0 16.1 11.5 12.6 P60-80 $52,137 7.3 11.6 1.6 0.0 20.5 20.0 20.8 P80-90 $83,012 9.2 11.9 1.6 0.0 22.7 15.9 16.1 P90-95 $117,709 11.6 11.5 1.8 0.0 24.9 11.3 11.1 P95-99 $199,033 16.4 8.1 2.5 0.1 27.2 15.3 14.5 P99-99.5 $428,690 21.4 4.6 3.7 1.6 31.3 4.1 3.7 P99.5-99.9 $863,607 23.8 3.0 4.3 1.9 33.0 6.6 5.8 P99.9-99.99 $3,158,720 25.1 1.6 4.9 2.4 34.1 5.5 4.7 P99.99-100 $18,113,612 26.2 1.4 4.6 2.5 34.7 3.5 3.0 Table 1: Income and Federal Tax Rate Statistics in 2004 (based on 2000 inflated incomes) (Piketty & Saez, 2007, p.6). From this table it can be realized that the federal tax system in the U.S. has led to several tax payments with varying rates by the income individuals over the years. In this all four federal taxes are considered that include the individual income tax, the corporate income tax, the estate and gift tax, and the payroll taxes as well. The taxes affect the distribution of income severely. The share of pre-tax income for each group is displayed in the eight column of the Table 1 as provided above. The last column reflects the share of post-tax income for each group. Several themes are explained by these statistics. Firstly, the federal tax system all together was progressive in the year 2004. “The post-tax share of income is higher than the pre-tax share of income for those income groups that are lower in the income distribution; conversely, the post-tax share of income is lower than the pre-tax share of income for the groups highest in the income distribution, above the 90th percentile” (Piketty & Saez, 2007, pp.7-8). Secondly, based on the statistics it can be said that although the extremely zenith groups are incredibly minute in regard to the number of families, they symbolize “a large share of income earned, and an even larger share of total taxes paid. For example, the upper 1 percent of the income distribution earned 19.6 percent of total income before tax, and paid 41 percent of the individual federal income tax and 28 percent of all federal taxes” (Piketty & Saez, 2007, pp.7-8). To understand the progressivity of the federal taxes in the U.S. researchers had also determined an index reflecting the progressivity of the federal taxes. The index is as given below: Year Federal Income Tax Progressivity Index Relative Index 1980=1.00 1980 0.2138 1.000 1981 0.2003 0.937 1982 0.2050 0.959 1983 0.2133 0.998 1984 0.2169 1.015 1985 0.2204 1.031 1986 0.2409 1.127 1987 0.2347 1.098 1988 0.2351 1.100 1989 0.2235 1.045 1990 0.2227 1.042 1991 0.2325 1.088 1992 0.2498 1.168 1993 0.2666 1.247 1994 0.2679 1.253 1995 0.2746 1.285 1996 0.2840 1.328 1997 0.2841 1.329 1998 0.2934 1.373 1999 0.3014 1.410 2000 0.3031 1.418 2001 0.2997 1.402 2002 0.3248 1.519 2003 0.3227 1.510 Table 2: Income Tax Progressivity Index (Hyman, 2007, p.584). From the index it can be realized that the progressivity of the income tax has been increasing since the year 1980. The progressivity has been recorded to be lesser in between 1986 and 1991 that accounts for the period after the Tax Reform Act of 1986 came into existence. However, increases in the marginal tax rates in between 1990 and 1993 resulted in further increase in the progressivity of the federal taxes. Several reasons have been associated with the increasing progressivity of the federal taxation system in the country. Most of the states have associated their income taxes with the federal taxes. This simplifies the administration of the taxes particularly in times when there are changes in the federal system of taxation (Hyman, 2007, pp.584-586). However with the gradual changes in the tax rates, the tax burden on the income groups started increasing. This may be studied from the following table: Average Federal Tax Rates (Percent) Income Groups 1960 1970 1980 1990 2000 2004 Full population 21.4 23.3 26.6 25.8 27.4 23.4 P20-40 13.9 18.5 16.3 16.2 13.1 9.4 P40-60 15.9 20.2 21.4 21.0 20.0 16.1 P60-80 16.7 20.7 24.5 24.3 23.9 20.5 P80-90 17.4 20.5 26.7 26.2 26.4 22.7 P90-95 18.7 21.4 27.9 27.9 28.7 24.9 P95-99 23.5 25.6 31.0 28.6 31.1 27.2 P99-99.5 34.0 36.1 37.6 31.5 35.7 31.3 P99.5-99.9 41.4 44.6 43.0 33.0 38.4 33.0 P99.9-99.99 55.3 59.1 51.0 34.3 40.2 34.1 P99.99-100 71.4 74.6 59.3 35.4 40.8 34.7 Table 3: Federal Tax Rates by Income Group from 1960 to 2004 (Piketty & Saez, 2007, p.13). The above table reflects the outline of federal average tax rates for different income groups in 1960, 1980, 1990, and 2000, and the projection for 2004. From the above data a flattening of the tax structure can be reflected. In 1960, the collection of the average taxes was moderately flat up from the 20th to the 90th percentile, followed by a sharp increase. By 1980, there was a sharp decline in the collection of average taxes from the extremely zenith income groups, particularly in the top percentile, at the same time as average tax rates collected from between the 40th and 95th percentiles had gone up. “From 1980 to 1990, tax rates at the top declined, while tax rates in the middle class stayed constant. In the 1990s, tax rates increased only within the top 5 percent. The 2004 projected tax rates restore lower rates of 1990 at the top and reduce tax rates on the middle class below the levels of 1980, 1990, or 2000” (Piketty & Saez, 2007, p.13). The Fair and Flat Systems of Taxes: The current progressive taxation system in the U.S. has proved to have significant negative impacts on the society. The individuals of the society are eventually being punished with this system being in place. The current tax system is challenged with ambiguities and prejudices that upset individuals who put aside funds for the future. “Not only does our tax code treat citizens differently but it is hopelessly complicated. According to the IRS, the average taxpayer spends 26.5 hours preparing and sending in their taxes. The ever-growing Internal Revenue Code is now over 3 million words. It’s far too complex, intrusive and long” (Flat Tax vs. Fair Tax, 2011). With the current scenario of taxation system in the U.S., the Fair Tax system proves to be most effective for the country. Since this taxation system treats all individuals equally as well as considers the difficulties of the lower income groups people, this would suit the countrymen best for their tax payments (The FairTax Plan, 2013). The fair tax is also better than the flat tax since the fair tax phases out the Internal Revenue Service. Moreover, it prevents taxing exports and reinvested income. The FairTax allows the economy to develop. On the other hand, the flat tax inflicts a tax on both these items. The governments are also helped in controlling their spending with the fair tax in place. The Social Security and the Medicare are also benefitted by the fair tax since it enables stabilization and growth of the revenues in these fields, as well as through the elimination of the payroll taxes, the workers are also benefitted (Bennett, 2013). However whether the country is able to change their present situation in relation to tax depends since the politicians of the country “love the imponderable maze that is our tax system” (Osterman, 2012). Conclusion: From the above study it can thus be concluded that the Fair Tax System would suit the U.S. the best considering the present situation of taxation and the consequent effects on the country and its people. The present progressive system of taxation proves to be highly difficult and complicated with systems of taxes that are having negative impacts on the people of the country. The Flat Tax and Fair Tax systems being two other alternatives of taxation systems, it can be said that the country can plan and alter their taxation system and choose any of these intending to improve the present situation. However considering these two forms of taxation as well as the effects of the progressive system, as obtained from the above study, it can be concluded that the benefits of the fair tax are higher than the other systems as far as U.S. and its people are concerned. The fair tax eliminating the federal taxes as well as considering the difficulties of the lower income group people would add several advantages for these people and for the country as a whole. Hence, from the study it may be concluded that the fair tax would be best for the U.S. References Amadeo, K. (2013). 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