The Flat Tax Proposal

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The Flat Tax Proposal
Consider what government is all about. It can be summed up in one word: Taxes. Regardless of location, party denomination or political structure, just as an army reputedly "travels on its stomach," a bureaucracy travels on its citizens' billfolds, and everyone entering government service sooner or later comes to share this attitude. Left to the devices of the officials, there is no limit to the amount collected, and any attempt by the payors to minimize the tribute will be met with warnings of dire consequences that never end. In California, home of the famous (or infamous) Proposition 13, the initiative measure which in 1978 cut property taxes by half and limited future increases to 2 percent per year, tax beneficiaries to this day blame every malady except the sinking of the Titanic on the passage of that proposition. The fact that the state and all its political subdivisions are literally awash in money does not dampen the enthusiasm of many to rescind that law.

As the intent of the collectors to shear the public is clear, so is the attitude of the shorn. It requires no great awareness to understand that your money is taken. For this reason, the politicians must regularly genuflect to the concept of tax relief, and an endless variety of proposals are periodically floated to convince the citizens that their best interests are uppermost in the minds of their leaders. Think back, if you will, to the spectacle of political candidates falling all over themselves with conflicting tax reduction plans prior to the 2000 national elections. The called-for relief stressed the conventional palliatives including marital deduction reform, capital gains revision, and general rate reduction. As predictable, the sound and fury following the election came to mostly nothing, short of ballyhoo over how each citizen might best spend a $300 per head governmental gift.

One of the more fascinating suggestions that surfaces from time to time is the idea of a "flat tax." As the concept is actually taken seriously, it is worth discussing. Income tax in the United States is assessed and collected in what are known as "brackets," of which five presently exist for the average taxpayer. As a person's annual taxable income rises, the rate at which it is taxed increases with each higher bracket. A tax system with a wide percentage variance between the lowest and highest brackets is referred to as progressive. The proponents believe it fair that those with the larger incomes pay a greater percentage of that income in taxes. However, it is by the granting of various exclusions, exemptions, deductions, and credits that taxation of income takes on its true character, and it is through the use of these devices that the effective rates are distorted into a bewildering array of meaninglessness.

This brings us now to the flat tax, which, at its simplest, is the taxing of all income from whatever source, with no exemptions or exclusions, at a single rate. This concept is propounded from time to time by various political candidates in the hope that its simplistic approach will somehow capture the hearts and imaginations of the beleaguered tax-paying voters. Its supporters include representatives of both major parties, where variations on the specific details are introduced in order to satisfy one or another special interest group. Though popularized by Republican Stephen Forbes in both his 1996 and 2000 presidential bids, a decade earlier Oakland Mayor Edmund G. (Jerry) Brown, Jr., a former Democratic governor of California, championed it with an equal lack of success. Over the years the flat tax concept has remained a durable issue for those candidates utilizing the Christopher Columbus approach to electioneering: just discover an issue and land on it.

My objection to the flat tax is its offer of tax simplification. For the taxpayer willing to understand and utilize the system, complexity is desirable, and the more, the better. Complexity, by its very nature, creates opportunities for creativeness--"loopholes," if you prefer. It also complicates the tax collector's ability, sometimes to the point that the entire process bogs down in a mass of self-contradictory rules and procedures. Ease of administration of a tax system normally results in maximum revenue to the collector, whereas complexity works in the taxpayer's interest. It is my belief that the sole hope for the citizen is a perpetuation of the presently existing labyrinth of tax laws. Only a system that provides an element of indecipherability will allow the knowledgeable taxpayer some maneuvering room.

A Little Tax Planning

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A Little Tax Planning
Seated here with my niece Pauline at The Fish Market in Irvine, California, one of my favorite restaurants, certainly ends the week on a high note. While waiting for the Manhattan clam chowder, Pauline is bringing me up to date on her family. " . . . so Barbara is starting her senior year at high school and Randy will be a sophomore. It’s hard to realize, Uncle Al, that Jim and I will be celebrating our twentieth anniversary in just a few months."

"It’s sort of unreal to me too," I said. "It seems as though I attended your wedding only a few years ago, and Jim had just started with Barnes and Standard in the shipping department. Tell me, how are things going for him now?"

"Couldn’t be better. He received another promotion last month—he’s assistant to the plant manager now."

"Why, that’s great. It’s a fine fellow you’ve got. Oh, and by the way, how is that little antique business you started up a few years ago. Is it finally showing some signs of life?"

"Yes, it is . . . at last. I’m working with a woman that does furniture restoring, and that’s breathed some life into things. I’ve developed several sources for locating fine old pieces, and I’m starting to build a base of repeat clients. The fact is, I made almost forty thousand dollars last year and as things are going, it should be fifty this year."

"Um, that’s wonderful . . . " I remarked, but as the words came out, several discomforting thoughts came to mind. After a few moments, I leaned a little closer across the table and said: "Pauline, do you mind if I ask you a few specific questions about your business?"

"Why, not at all, Uncle Al. What do you want to know?"

"Well, first off, what form of business entity do you use?"

"I’m not sure what you mean," she said.

"Well, did you organize as a partnership, or perhaps an S corp, or simply as a sole proprietor?"

"Eh, that last one, I guess. I just filed a business notice in the name Pauline’s Antiques."

"That’s what I thought, which means your accountant lists income and expense as part of your and Jim’s 1040 tax return on a Schedule C."

"Yes, that’s right. Is that good or bad?"

Pushing the now empty clam chowder bowl to the side, I reached for a slice of The Fish Market’s exquisite sourdough bread. "Well, I’ll give you the facts and then you can decide whether it’s good or bad—but first I have to ask a personal question."

"Anything," she said.

"How much is Jim’s salary now at Barnes and Standard?"

"He’s getting sixty-five thousand a year."

As I leaned back in my chair once again, I mentally added numbers as the picture came into clear focus. Then peering directly at Pauline, I said: "Here’s the way it is: Though you may make fifty thousand this year, you’ll only get to keep about half of it."

I watched as a look of disbelief formed on the face in front of me. "What do you mean that I’ll only get to keep half of it?" she exclaimed.

"Here’s the way it works," I said. "With the joint return that you and Jim file, your income is simply added on to the top of your federal tax bracket, which is 25 percent up to about $115,000, and goes to 28 percent above that. You can then add on another 9.3 percent for California tax. Finally, every dime you make will have an additional 15.3 percent for FICA tax—that’s your contribution to the Social Security system. All together, almost 50 percent comes right off the top. You’ll get to keep maybe $25,000. Now you tell me, is it good or bad?"

"It’s terrible! How can they do such a thing?"

"That’s something that would take me about six hours to explain," I said, as the waitress arrived with two luscious orders of rainbow trout."

Pauline grimaced. "I think I’ve lost my appetite,"

I smiled slightly as I said: "Maybe things aren’t all that bad. There’s another way to skin this cat, if you’d like to hear about it."

"Anything."

"It’s fairly simple. You run your business as a corporation instead of as a sole proprietorship."

"How does that change things?"

"I’ll explain. To begin with, federal corporate income tax on the first $50,000 is 15 percent. In the second place, income to the corporation that’s not passed on as salaries is exempt from the FICA tax. And even the state helps a little with a slightly lower corporate rate of 8.84 percent. So these three items will represent a savings to you of almost $13,000. Now, does that strike you a little better?"

"Uncle Al, your suggestion certainly sounds reasonable. But just one thing: what are the drawbacks?"

"Pauline, you’re starting to ask the right questions. Yeah, there are a few things to consider. Most important, do you have to draw out any of your profits for living expenses, or can you, Jim, and the kids get by on his salary?"

"We do just fine on that. I don’t need to dip into any of the business income."

"Good, then you can pull it off. It means that the corporate profit will remain as undisbursed assets. There is, however, one complication that you’ll eventually have to face, but it’s manageable."

"And what’s that?"

"It’s something called accumulated earnings surtax, which is 15 percent collected on top of normal corporate income tax. You see, the IRS doesn’t like corporations to hoard earnings. That interferes with the double taxation they understandably find to their liking. Fortunately, however, there’s some leeway. An accumulated earnings credit of $250,000 prevents assessment of the tax until the aggregation reaches that amount. That’ll give ample time to arrange things; I’ll help you with that when the time comes. In the meanwhile, with the services of a law firm I can recommend, together with your accountant’s help, you can be set up and functioning in no time at all."

"Uncle Al, you’re a lifesaver. I’ll get on it right away. I certainly feel better."

"Pauline, it’s a pleasure. Now, is there anything else I can do?"

"Yes there is," she said, with a broad grin. "Pass the tartar sauce . . . my appetite’s come back.".

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