The Graduated Flat Tax — A Good Approach (Nov 2011 Update)

The method for calculating the amount of tax that any citizen would owe using my proposed graduated flat tax approach is as follows:

The first $20,000 of income for all individuals would be tax free. The next $80,000 of income (amounts between $20,000 and $100,000) would be taxed at the rate of 10%. The next $100,000 of income (amounts between $100,000 and $200,000) would be taxed at 20%. Additional income amounts above the first $200,000 of income would be taxed at 30%.

Application of the above approach would yield the following effective tax rates for a number of income levels:

Individual Annual Income Effective Tax Rate (percent)
$20,000 0%
$40,000 5%
$100,000 8%
$200,000 14%
$300,000 19.3%
$1,000,000 26.8%
Highest Income < 30%

There is considerable discussion these days about replacing the current federal income tax approach with a flat tax. The problem with the flat tax variations currently being proposed is that they are not progressive (tax rate increases as the taxable amount increases).

Some corporate executives, entertainers, and professional athletes are currently paid more than 20 million dollars a year. We live in a free enterprise society in which people are allowed to be paid as much as they can earn even though it may be substantially higher than the current national median household income of around $50,000 per year. The problem isn’t so much with the money that they are paid, but that they are able to avoid taxation on the money through various tax loopholes.

If people being paid 20 million dollars a year were to pay federal taxes at about a 30% tax rate with no loopholes, the tax amount would be approximately 6 million dollars per year in federal taxes which is indeed a substantial amount of money. However, a person being paid 20 million a year would still be left with about 14 million a year after federal taxes which is certainly a very substantial sum as well. The point is this. Those who are benefiting the most financially from our free enterprise system, with great amounts of disposable income, can and should be expected to pay a greater percentage of their income to preserve our way of life than those struggling to survive financially.

We can achieve the benefits of an essentially loophole free flat tax strategy while maintaining a progressive approach by establishing several flat rates. What are the benefits of a graduated flat tax? With the method that I am proposing, some of the benefits would be as follows: 1) Taxes would be lower for most middle income taxpayers. 2) Most people would not have to file a federal income tax form. 3) The marriage penalty would be eliminated since income taxes would be on an individual basis. 4) With a simpler tax code, the impact of lobbyists on our national legislators would be greatly reduced.

With the graduated flat tax that I am proposing, there would be no deductions or credits other than 401k retirement savings accounts and Individual Retirement Accounts which would be treated the same as they are now.

Federal income taxes on wages, tips, and other compensation would be withheld by employers and sent into the government much as they are now.

Interest and dividends would be taxed at the rate of 10%. The taxes would be withheld and paid into the government by banks and brokerage houses. The first $10,000 of combined interest and dividend income for each taxpayer would be excluded from taxation. The government would return the amount of taxes collected that are less than or equal to the exclusion amount to the taxpayer.

Short and long term capital gains from stock sales would all be taxed at 15% with taxes collected and sent to the government by brokerage houses. Short and long term capital losses would also be reported to the government, as well as to the taxpayer, by brokerage houses. The government would calculate and return any overpayment of capital gains taxes after capital losses are figured in. Some capital gains such as those resulting from the sale of rental property would still be handled with a simple capital gain/loss form.

While the specific details are subject to debate, some variation of a fair and understandable graduated flat tax would be far better for most working Americans than the present approach.