Time To Get Rid Of The Federal Income Tax

Financial Samurai had a very interesting post on a Fair Income Tax Policy In America. This got me thinking as to what would be the best tax system for the United States. It may finally be time to move from our income based tax syatem to a better alternative.

According to the Congressional Budget Office, households that made between $34,300 and $141,900 paid 50.5 percent of all federal tax revenues in 2007. This group of middle class and upper income Americans contribute more to government tax receipts than the rich and lower income individuals. If you add in the next group of wage earners, individuals that earned between $34,300 and $352,900 paid 66.7 percent of all federal taxes in 2007.

The ultra rich actually pay lower tax rates than the middle class and upper income wage earners. In a Forbes interview, Warren Buffett stated that he pays too little in taxes. His effective tax rate falls between 16 and 17%. Buffett says that he pays less income taxes than his secretary and most of his employees. Since he receives the bulk of his income through investments, his income is taxed at the much lower dividend and capital gains rate. Buffett’s employees who make up to $75,000 per year are taxed at a 33% rate. Mark Cuban agrees with Buffett’s assertion. Cuban told Forbes that his employees pay a higher percentage of their income in taxes than he does.

Under our current tax system the middle class and upper income Americans pay a disproportionate amount of taxes. We currently have a progressive income tax system that taxes investments at a lower rate than earned labor income.

In my opinion the best system of taxation for all taxpayers would be a tax system based on consumption. A consumption tax only taxes money spent on goods or services. You would only pay taxes when you spend money. This would give every person control over exactly how much money they pay in taxes. For those that want to pay more in taxes, they can consumer more. Those that would like to pay less can consume less. The consumption tax could be progressive so that you pay more taxes as you consume more.

The consumption tax could be in the form of a value added tax or national sales tax. The tax would have to be phased in over years so that older American would not be unfairly punished. Older Americans often live on a fixed income and a rise in the price of goods and services would be a shock to their pocketbooks. Poorer individuals could be given exemptions so that they are not unfairly burdened.

The good thing about a consumption tax is that it would actually motivate Americans to save more. We would go from being a nation of debtors to a nation of savers. As we saved more money, we would be less dependent on government services enabling Congress to reduce entitlement spending on programs like Social Security. Our economy would actually get stronger over time.

P.S. No more scrambling to file your taxes by April 15^th. Your taxes are paid whenever you buy something!

Photo by: Mat Honan