The Graduated Flat Tax — A Good Approach

Over the past few years there have been some discussions about replacing the current federal income tax approach with a national sales tax or a 17% flax tax.  The problem with both of those alternatives is that they are not progressive (tax rate increases as the taxable amount increases).

A CNN/USA Today/Gallup Poll shows that the public believes that low-income and middle-income people are paying too much in federal taxes, while high income people are not paying their fair share.  If the public believes the existing progressive system unfairly favors the rich, then it is understandable why it has not been receptive to either a national sales tax or a 17% flat tax proposal because both approaches are not progressive and would result in high-income taxpayers paying even less.

It is possible to achieve the benefits of a flat tax 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 low-income and 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.

Here is how the graduated flat tax would work.  Every taxpayer would pay no tax on the first $20,000 of income.  The next $80,000 [amounts between $20,000 and $100,000] would be taxed at the rate of 10%.  The next $100,000 [income amounts between $100,000 and $200,000] would be taxed at the rate of 20%.  Additional income amounts above $200,000 would be taxed at 30%.

There would be no deductions or credits for anyone other than 401k retirement savings accounts and Individual Retirement Accounts which would be treated the same as they are now.  Nevertheless, most middle income taxpayers would pay significantly less using my approach.

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 loses 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 losses are factored 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.