Here’s One Approach to Tax Reform: The Common Sense Tax

Tax reform might have been buried as a priority on Capitol Hill amidst the debt-ceiling debate, government shutdown and the launch of the Affordable Care Act’s health insurance exchanges, but there have been hints reform is in the works.

But changing a few laws, repealing a few and creating a few more will only add to the already burdensome tax code. What we need is massive simplification.

I say let’s stack those 73,000 pages onto a bonfire and start all over again. Laurence Kotlikoff, a professor of economics at Boston University agrees. He and John Goodman, president of the National Center for Policy Analysis have developed the Common Sense tax that would replace the current tax system with only two taxes: a business paid tax on employee wages at a flat 13% (FICA) and a personal income tax on household income above $100,000 for married filing joint, and $50,000 for singles at a rate of 25%.

Employees will not pay taxes on their earnings unless they make more than the amounts indicated above - $50,000 for single filers and $100,000 for married filers. And it’s only the amounts earned above those ceilings that will be taxed. For example, if you are single and make $51,000, you will pay taxes on only $1,000 that is above the $50,000 threshold: meaning your tax liability for the year will be $250.

The rate of 25% is not carved in stone. According to the The Common Sense Tax  website , “The Congressional Budget Office will need to score the proposal to determine whether the rate needs to be higher or lower to achieve revenue-neutrality.”

Only one deduction is allowed against household income under the duo’s plan so the vast array of itemized deductions we currently enjoy, which seem to favor home owners over renters, will disappear. The only deduction allowed under the plan is for charitable contributions. The child tax credit and the earned income tax credit – a reverse welfare system – would also be preserved.

There would also no longer be a corporate income tax. However, businesses  would be required to pay a flat 13% tax on all salaries and wages paid to their employees.  Currently, employees pay 7.65% and business owners pay 7.65% in matching FICA and Medicare tax as well as 0.8% FUTA tax, which provides for unemployment benefits. They also pay taxes at the state and sometimes the local level. This will prove beneficial to businesses thus providing increased capital for expansion.

But big and small business will not be free from taxation. Kotlikoff says, “Any profit made by the business will be imputed to the owners of the corporation and they will pay tax on it at a personal level.”

According to the website, “The reform is designed to be revenue neutral and progressive. It would eliminate annual income-tax filing for over two thirds of American households and kick start our ailing economy, primarily by eliminating the corporate income tax, whose burden arguably falls on workers, not American shareholders of U.S. corporations.”

What about the underground economy? According to the IRS, the nation’s current $486 billion tax gap is due in large part to the underground economy. Proceeds from illegal operations, under-the-table operations, and undocumented workers will remain untaxed. However, Kotlikoff states, “The underground economy should shrink because you can make $50 ,000 or $100,000 without owing taxes. Many under-the-table businesses and undocumented workers do not make in excess of this amount.”

Another point in favor of the Common Sense Tax is that the only audits will likely be on businesses or perhaps on individuals who claim charitable contribution deductions. And the audits will be far less invasive.

“Overall,” Kotlikoff states, “The Common Sense Tax is more progressive and simple than the current system and it lowers the FICA tax.”