Proposal for Restructuring
of the U.S. Federal Income Tax System
Edward J. Dodson
[Submitted for consideration to the President's Commssion on Tax
Reform, April 2005]
The objectives of reform of how our Federal government raises revenue
ought to combine simplification of compliance with progressivity,
without being excessively confiscatory. The history of tax law and
regulation in our country is a history described by political
scientists as one of "disjointed incrementalism." Principle
has taken a back seat to expediency and the politics of bending to
special interests to the detriment of the common interest. My proposal
is the replace the existing Federal income tax structure with a "graduated
flat tax" system." The details are as follows:
- Tax Base. Individual incomes independent of the source
would be reported.
- Exemptions, Deductions and Exclusions. Individual
incomes up to some maximum (the national median is suggested)
would be exempted from taxation. No other deductions, exemptions
or exclusions would apply.
- Tax Rates. Individual incomes above the above exclusion
would be taxed at increasing rates of taxation, up to a maximum
rate established periodically based on the requirement to achieve
a balanced budget. For purposes of example, assume the national
median income is $50,000. The graduated flat tax structure would
impose a rate of, say, 5% on incomes greater than $50,000 up to
$100,000; 10% on incomes greater than $100,000 up to $250,000; 15%
on incomes greater than $250,000 up to $500,000; 20% on incomes
greater than $500,000 up to $1 million; and, 25% on incomes
greater than $1 million. Note, the exact rates and income ranges
can be adjusted as needed.
- Distribution of Tax Burden. The above structure
effective exempts virtually all low-income individuals from
taxation. Moreover, the effective rate of taxation is lowest on
activities most directly associated with the production of goods
and services. Incomes received by passive investment will (by
virtue of the actual distribution of such sources of incomes)
experience higher rates of taxation.
- Treatment of Charitable Giving. This proposal provides
for no special consideration of charitable giving. A provision to
permit deductions from gross income for such contributions adds
complexity (and the tracking of whether the recipients are
legitimate charitable organizations imposes duties on the Internal
Revenue Service which have proven difficult to perform to this
- Treatment of Home Ownership. This proposal provides no
provision for deduction of mortgage interest or local real estate
- Collection Method. The graduated flat tax structure as
proposed results in enormously simplified forms required for
compliance. All income recipients would continue to file an annual
report of income, and employers would continue to provide
comprehensive reporting on incomes received by employees.
- Treatment of Businesses. This proposal also recommends
ending the imposition of the current tax on gross profits, to be
replaced by a flat rate of taxation on gross revenue received by
businesses. This change would accomplish two things: first,
simplify compliance (reducing the need for the current army of tax
accountants and tax attorneys employed by almost every business);
and, second, reward success rather than inefficiency, as
businesses with the same gross revenue will be taxed identically
regardless of expenses incurred.
Impact of Proposal Relative to Current System
This proposal has obvious advantages in terms of simplicity. The
potential to greatly reduce the tax collection bureaucracy are real.
There is also real potential to shift resources to the extremely
important societal issues of better regulating the nation's corporate
sector. The fairness of this new structure is also readily apparent.
Individuals who receive all or virtually all of their incomes from
wages or salaries will be exempted or very lightly taxed. At the top
end, the maximum rate will confiscate very little of incomes earned by
producing goods or services and is (as measured by recent history)
The longer-term potential reduction in the "tax collection"
industry and bureaucracy will contribute to the nation's economic
growth and competitiveness. Modest rates and reduced complexity will
result in greater compliance and huge savings in the costs of
compliance for individuals and businesses, as well as administration
costs incurred by government.
Transition, Tradeoffs and Special Issues
Two very important and intimately related issues are: (1) the need
for legislation requiring government to raise sufficient revenue by
taxation and other fees (e.g., the leasing of public lands to private
interests under conditions of competitive bidding to achieve market
rates of return); and (2) the gradual reduction in the nation's debt
by conversion of existing debt as it matures with fully amortizing
bonds that return to investors both interest and principle. The debt
service payments required to achieve this result would need to be
included in the budgeting process.