The <i>Freedom</i>Tax 2.0: A 10%, Or Lower, Flat Tax Plan

The FreedomTax 2.0: A 10%, Or Lower, Flat Tax Plan

Fundamental tax reform to bring
simplification and fairness to everyone

Background

Over the past 50 years, there have been countless reforms to the income tax, none achieving real and lasting reform. All have been at the edges of the tax system (e.g., to alter the tax brackets, rates, deductions, etc.), but never to change the fundamental nature of the tax system itself.

An old curmudgeon once remarked, “You can’t fix a squeaky floorboard by pounding more nails into it year after year.  At some point, you need to rip it up and replace it.”

The latest nail is the Tax Cut and Jobs Act (“TCJA”) enacted in December of 2017. Judging from taxpayer complaints and the extensive IRS problems in writing rules to implement this latest reform, it must be seen as an anti-reform measure. Yes, it’s cut taxes, but it’s made the tax law even less coherent, more cumbersome, and more difficult to administer. The floorboard still squeaks.  And, with the TCJA ink barely dry, efforts are underway for more nail pounding, oblivious to achieving anything fundamental.

Easy to see, the income tax is not a true income tax.  Easy to miss, the income tax actually is a person-taxing system. This reality, ignored in the past reforms, explains why the income tax is left squeaking, crying out for more reform. [1]

Person-Taxation.  Just because a tax is applied to income, doesn’t make for an income-tax system. Under person-taxation, the role of income is in the computation of the amount of tax to be imposed on the targeted person.  Today, every person with “taxable income” is required to file a personal return with the IRS to “self-assess” the tax against himself. In this return, he reports his income, claims his personal tax breaks, and computes the tax owed (using the tax-bracket rates applicable to him and deducting his personal tax credits). The tax is imposed on him, not his income.

The tax is person-specific. Looking to income, it’s rare to find any two persons paying at the same effective tax rate. The rate varies depending upon each person’s personal situation, the nature of the income to him, and how he might spend or invest his income.

With tens of millions of personal tax returns filed every year, this self-assessment system of tax collection is highly inefficient and difficult to administer. The cost and time required of taxpayers to comply is scandalous, amounting to an additional tax on them and producing no revenue to the Treasury. Vast sums of income escape taxation. Taxpayer disputes are common. And, with everyone filing a personal return every year, it’s a ready vehicle for the implementation of frequent tax-law changes and an easy system for tax-targeting. Other taxes, not paid via personal tax returns, don’t have these issues.

So, it’s no wonder that person-taxation has been the enabler of the tax mess. It has bred the inordinate tax-complexity, disparity in tax rates, tax-driven decision-making, etc.[2]

If Other Taxes Were Self-Assessed. The nefarious nature of person-taxation would be readily seen if it were to be applied to the motor fuel tax on gasoline purchased and collected at the pump. The fuel tax is a simple tax, having no perceptible IRS involvement.  But, if it were to be converted from a tax collected at the pump to a self-assessment tax on the motorist, all efficiencies would end. Every motorist would be required to file an annual “Personal Motorist Return,” reporting all of his gallons purchased during the year and computing his fuel tax owed.  Imagine the new record-keeping required of all motorists and the many who would be struggling each year to prepare and file their motorist tax returns and pay the tax.

This would give Congress and the IRS a power over motorists not now present.  Congress likely would move away from having the current single tax rate on gallons purchased and add graduated tax brackets applicable to the heavy users, imposing higher rates if their annual reported gallons exceed “fair” levels of motoring.

Also, Congress could create fuel deductions for car-pooling and trips to see the doctor or to do charity work, etc.  And, in the case of motorists driving luxury or gas-guzzling vehicles or who do too much recreation-driving, there could be special rules imposing higher tax rates on their fuel purchases,  For those driving “green” cars or even American-made cars, they could be given a lower fuel-tax rate.

Replacing the Squeaky Floorboard

The squeaky floorboard is person-taxation.  It’s not the entire building in need of replacement. This, however, is the assumption behind proposals to repeal the income tax and replace it with a consumption tax or some sort of national sales tax, such as the “Fair Tax” or Value Added Tax (VAT).  These proposals are likely to lead to tax messes of their own.[3]

The FreedomTax is the more responsive approach.  It accepts the concept of having an income tax, but under a modernized system allowing for a true income tax.[4]

The Three Pillars of the Freedom-Tax

1. Person-Taxation to End.  The FreedomTax would end person-taxation as the universal system to collect the tax.  With this, there would be an end to the personal tax breaks and tax subsidies found in the Tax Code, commonly referred to as “tax expenditures.”[5]

As revolutionary as this may seem, it’s important to recognize what real income-tax reform is NOT about.  It’s NOT about changing the role of government in serving the needs of people.  Nor, is it about ending government-provided relief to those in need, or to those deserving a subsidy.[6]  These needs can be more appropriately accommodated and met through direct-payment programs rather than as tax-expenditure programs embedded in the Tax Code, mucking-up the tax law.  Moreover, the IRS is ill equipped to be an agency in charge of monitoring spending programs and reporting back to Congress on their efficacy.

2. Focus on Income. The FreedomTax’s end to person-taxation will allow for the tax system to be restructured and focused, with income the subject of taxation.  This leads to a governing principle that all income should bear its fair share of the tax.  Moreover, focus and fairness calls for all income to be taxed the same, with no exceptions, special rules, or variances in the tax rates.

The present tax system has no governing principle of income taxation.  It’s a cobbled-together system of higgledy-piggledy rules that this income should be taxed (or not taxed) and, if taxed, taxed at this rate or that rate, all depending upon variables related to the person being taxed.[7] Lacking in principle, the present tax system has no first-line-of-defense to debate and rebut proposed tax-law changes which erode the tax base, add to tax-complexity, and exacerbate the tax mess.

3. At-Source Tax Collection.  Perhaps most revolutionary about the FreedomTax is that the income tax would be collected at the source of payment in the case of most forms of income – dividends, interest, salary and wage, and retirement income.  As a result, the FreedomTax would free individual taxpayers from having to file an income tax return to report and pay the tax on this income. For them, paying the income tax would become as easy and simple as paying the gasoline tax at the pump.

With the tax focused on income rather than persons, there would be no need for a separate income tax system for corporations. Business income would be taxed at the same rate as that of individuals.  However, because business income is determined only after taking into account business expenses, business tax returns still would be required, with the tax on that income paid by the business itself.

As to partnerships and other pass-through entities with business income, the FreedomTax would end the current requirement that the partners and the other pass-through-entity owners report, in personal tax returns, their respective shares of entity business income and pay the tax themselves.[8] As just discussed, all business income would be reported in tax returns at the business level and the tax paid at that level. What partners and other entity owners would be entitled to from their entities will have already been taxed. So, here too, there would be freedom from personal-tax-return responsibility.

The FreedomTax – the Nuts and Bolts

There are eight elements to the FreedomTax: (see details in the endnotes)  –  (1) single-rate taxation; (2) comprehensive tax base; (3) at-source tax collection and end to personal tax returns; (4) integration of corporate and personal taxation; (5) no capital gains taxation; (6) extensive tax-simplification; (7) end to estate and gift taxation; and (8) end to worldwide taxation:

1. Single-Rate Taxation.  The FreedomTax comes with a proposed single-tax rate of 10%, imposed on all income without regard to recipient, etc.  But, an enacted FreedomTax is likely to have this 10% tax rate set much lower.[9]

Single-rate taxation is the key to having a greatly simplified, tax-efficient income tax system.  Under the FreedomTax, no longer would there be tax-brackets[10] – e.g., different tax rates for taxpayers who are single, married and filing jointly, married but filing separately, a head of household, or a trust, estate, or corporation.  No longer would there be different tax rates based upon total reported income or types of income. No longer would there be the so-called marriage-tax penalty or the “kiddie tax.”  No longer would there be any add-on taxes, such as the Alternative Minimum Tax or the 3.8% tax on investment income, nor would there be any penalty taxes imposed, such as the recent Obamacare penalty tax on persons failing to follow a Government mandate.

2. Comprehensive Tax Base.  The FreedomTax would greatly expand the income tax base (more so than in the study of the Tax Foundation discussed in endnote 10).  All compensation income would be included in the tax base, including the value of all employer-provided fringebenefits.[11]  Also included in the tax base would be state and local    municipal bond interest, all income earned from tax-advantaged investments,[12] and the income earned by tax-exempt entities.[13]  All exemptions, itemized deductions, special deductions, exclusions, and tax credits would end.[14]  And, all Government transfer payments, such as the value of food stamps received, represent income received by, or paid for the benefit of, the recipient and would be taxable.[15]  All of this income would be included in the FreedomTax base and hence subject to at-the-source withholding.[16]

Moreover. the FreedomTax would end the special tax breaks allowed to business.[17]  In a regime of low tax rates, tax breaks lose their importance and represent unneeded complexity.[18]

3. At-Source Tax Collection and End to Personal Tax Returns.  Under the FreedomTax, individuals would be freed of their personal tax-return and payment responsibilities to the IRS.  Dividend, interest, salary and wage, and retirement income would have the income tax collected and paid at the source of payment.[19]  The payor would deduct the tax and remit it directly to the IRS.[20]

However, as discussed above, individuals with income from rental property or from conducting a trade or business would be required to file a business tax return for this income.[21]  As with all businesses, their business expenses would be deducted from gross income, and the income tax on this business income would be computed and paid from the business to the IRS.

At-source tax collection is a simple and compliance-easy system of tax collection.[22]  The FreedomTax would place no tax withholding and payment burdens on everyday commercial transactions as businesses will have their own tax reporting and tax payment responsibilities.[23]

Form 1099 (and W-2) reporting no longer will be necessary for payors of dividends, interest, and salaries and wages. The payors of this income would be withholding and paying the tax on this income directly to the IRS, thus ending the need for the recipients themselves to again report that income to the IRS and pay the tax. This efficiency alone would be a major paperwork simplification for the tax system.

4. Integration of Corporate and Individual Taxation.  In contrast to present law under which corporate income is taxed first at the corporate level and again when distributed to the shareholders as dividends, the FreedomTax would tax corporate income only once.  It would treat the payment of dividends the same as interest; i.e., corporations would be allowed to deduct dividend payments to shareholders in computing their income along with interest.[24]  As discussed earlier, corporate income distributed to the shareholders as dividends would be subject to at-source income-tax collection.[25]

5. No Capital Gains Taxation.  Capital gains are not income, but are due to an increase in the value of property already owned before its being sold or exchanged for other property of the same value.  This means the sale or exchange transaction itself does not increase the owner’s wealth, nor amount to an in-flow of income.[26]  Thus, the taxing of capital gains is akin to property taxation of one’s assets and wealth.[27]

The FreedomTax recognizes that assets used in a trade or business are of a different nature, some depreciated as a cost of doing business and some bought and sold from business inventory.  Gains from the sale of these assets would not be considered capital gains,[28] but instead income from a trade or business.

6. Tax-Simplification.  At the more mundane level, many of the complicated rules under the present system intended to determine what is regarded as the “proper” or “theoretically-correct” income of the taxpayer,[29] can be eliminated in a regime of low-rate income taxation.  Many of these complicated rules relate only to the timing of income and are aimed at accelerating the recognition of income that will be taxed anyway in a later year.  A low tax rate renders many of these complications academic and unnecessary.

On the broader level, the FreedomTax’s overall simplification of the tax system means that entire parts of the Internal Revenue Code can be repealed as moot.  It’s estimated that the FreedomTax would reduce the Tax Code to less than 5% of its size today.  Among the many provisions to be eliminated (and no longer necessary given the low tax rate) are those granting tax credits, those granting itemized tax deductions, and those related to tax-exempt organizations (which no longer would be tax-exempt), etc.

Moreover, in a regime where corporate income is to be taxed only once and at the same tax rate as for individuals, the special taxes on the accumulated earnings of corporations and on personal holding company income would be unneeded and repealed.  Where capital gains are no longer treated as income, still other provisions can be repealed or substantially simplified.  And, with the redesign of our current tax system, inefficient in its operation and easily assaulted by tax avoidance and tax abuse, most of the civil tax penalty provisions added in recent years to prop-up the tax system no longer would be necessary and can be repealed.

And, very important to tax-simplication, the FreedomTax would be a positive at the legislative level, where much tax complexity originates. There, it’s wild-west without a governing principle to sheriff proposed tax-law changes. One tax change proposed is as good as any other.  The tax winner is the one or the gang with the most political fire-power.  It’s a common practice to enact special rules and exceptions to target some – but not all – taxpayers for revenue increases, and other provisions to target other taxpayers – but not all – for tax reductions.

The picking of winners and losers is NOT expected to occur under the FreedomTax.  This is because the FreedomTax is a plan for a principled income tax, with the tax system specifically structured for the no-exception inclusion of all income in the tax base and taxed at the same low rate. No longer would there be the filing of personal income tax returns to claim personal tax breaks or to vary the tax rates.  Under the Plan, revenue increases (or revenue decreases) would be implemented by changes in the general tax rate, uniformly applicable to all income regardless of recipient or what the recipient does with his income.

7. End to Estate and Gift Taxation. These taxes cost the IRS almost as much to administer as the revenue they raise. The estate tax with its near-confiscatory rate of tax causes many businessmen to take steps to mitigate its ultimate impact, diverting them from growing their businesses to the detriment of our overall economic growth.[30]

The estate tax is seen by many as another income tax, a tax on past income accumulated in property form[31] and failed to be spent before death. So, its repeal takes on importance in the achievement of real income tax reform, having a tax system for the uniform taxation of all income and taxed the same.[32]

The TCJA raises the estate and gift tax exemptions only for eight years until 2026 and leaves these taxes fully in place, still with impact on business decisions for estate-tax planning purposes.

8. End to Worldwide Taxation.  The FreedomTax would adopt the territorial system of taxation ending the current system of worldwide taxation, which most other countries do not follow. Worldwide taxation requires elaborate rules to deal with the many tax avoidance and double-taxation issues presented.[33]  It complicates the decision-making of U.S. companies operating abroad, and places them at a competitive tax disadvantage to companies headquartered in countries under the territorial system.[34]

Even worse, worldwide taxation represents very poor tax policy. It places the U.S. in the position of taxing income it has no justification to tax; e.g., income earned outside its borders under the laws and protection of a foreign country and under that country’s own tax policy.[35]

In terms of U.S. companies doing business abroad (commonly carried on through foreign subsidiaries), it adversely affects the deployment of their earnings back to the U.S.  Before the TCJA, those earnings were not U.S. taxed unless they were “repatriated” to the U.S.  The TCJA continues and even expands the reach of U.S. worldwide taxation to tax the foreign earnings retained by these foreign corporations and not repatriated.[36]

Observations

We Can, and Should, Do Better.  Had the income tax been designed and structured on the three pillars discussed above: 1) Ending Person Taxation; 2) Income NOT Person Focused; and 3) At Source Tax Collection, it never would have become the woeful mess of today.  Indeed, the income tax is in such a disheveled state that it presents the image of kaleidoscope design and offers acceptability to proposals adding to tax-system complexity and incoherence.

In this setting, the targeted tax cuts of the TCJA were aimed at corporations, less so for individuals. This meant that the corporate tax rates were cut more than were the rates for individuals. This disparity would cause individuals to pay higher taxes on their business income.  This business income comes from pass-through entities and proprietorships and is taxed at the individual rates.

To give relief, the TCJA added a special 20% deduction for them to claim against their business income. This is the deduction-way of reducing the impact of higher tax rates while maintaining high rates.[37]

Not only does the mere addition of a new deduction add to tax-complexity. This particular deduction creates even more complexity.  To restrict its impact, elaborate, difficult-to-apply rules are required to separate business income eligible for the deduction from passed-through professional income not eligible.

The nail-pounding can, and should, be ended. Proposed is the FreedomTax to replace our failing tax regime with a true income-tax system – simple, low-rate, tax-efficient, and tax-neutral.  The Plan is based on the idea, revolutionary to some, that an income tax system should be focused on the taxation of income, taxed the same, and all at the same rate.  Then, no longer could the income tax be used to pick winners and losers, or to target political opponents. The revolution is for all income to bear its fair share of the income tax burden.[38]

Objections. Many can be expected to raise objections to the Plan.  Some might contend that loss of the income tax deduction for charitable gifts will devastate charitable giving. But, this ignores that Americans have always been generous charity givers, even before there was an income tax and any deduction for charitable contributions.  The deduction functions as a subsidy for charitable giving and does little to motivate a gift to a charity.

The deduction for charitable gifts derives its value from high tax rates. Even if the deduction were to be retained, much of its value to taxpayers would be lost from the Plan’s huge tax-rate reduction to 10% (and likely lower).  Even so, under the Plan, contributions to charities remain as gifts to them, not income to be taxed.

Others might argue that ending the tax-advantaged status of pensions, IRAs, and other saving plans will damage U.S. saving and investment. This argument overlooks that these arrangements exist in the tax law to offset the disincentive effects caused by high tax rates.  When compared to the high tax rates under present law, the much-lowered tax rate by the FreedomTax actually would be a major positive for savings and investment.[39]

And, it will be contended that the Plan would hurt the poor, now largely shielded from the income tax.[40]  Again, real income tax reform is NOT about changing the role of government in serving the needs of people, NOR about ending government-provided relief to those in need, or to those deserving a subsidy. The goal here is for fundamental income-tax reform and to have a true low-rate income tax on all income, no exceptions.

Designing the income tax to exempt certain groups from the tax is to take the system back to person-taxation, to the filing of personal tax returns, to higher-rate taxation, and to return of the system inefficiencies and the tax mess, all from which the FreedomTax is to provide escape.

Concern that the FreedomTax would “bust the budget” is unjustified. The FreedomTax is designed and intended to be revenue-neutral (without resort to dynamic revenue-scoring to boost the numbers).  The Plan would raise at least as much tax revenue as the existing tax system (before enactment of the TCJA and the tax cuts it made).  This is discussed in endnote 10.

Conclusion

As already discussed, the FreedomTax is NOT about changing the role of the Federal Government in helping the poor. NOR, is it about ending subsidies where needed.  Rather, it’s about fundamental income tax reform.  It’s about having a true income tax – simple, low-rate, and compliance-easy.  And, it’s a plan to increase saving and investment returns and to foster economic growth for the benefit of everyone.  Well-worth observing again – The FreedomTax is the plan to make today’s income tax system, now functioning as a person-tax system, more closely compliant with literal language of the 16th Amendment.

Efficiency alone is enough to justify adoption of the FreedomTax. It would bring about major tax-simplification and huge tax-administration efficiencies, saving the Treasury billions in administration costs.  And, from the lessened compliance burdens, taxpayers will save even more (measured in dollars and their time).

The FreedomTax is the only plan having the design to free all individuals from having to file a personal income tax return – not even a postcard return.  For them, the income tax would become as simple and easy as paying the motor fuel tax at the pump. Enactment of the Plan having a simple and tax-efficient income tax will result in a massive downsizing of the IRS such that for most Americans, the IRS will have the same involvement in their income and personal affairs as paying the gas tax at the pump – tantamount to abolishing the IRS as we know it.


[1] Tax reformers unwittingly recognize this reality in the tables attached to their tax-reform proposals explaining who pays what under their proposals. And, this reality gives life to the mantra that many don’t pay their “fair share” of the tax.

[2] Many tax professionals have not come to this insight.  Following the first tax reform act (the Tax Reform Act of 1969) and later, a common quip voiced in the Tax Section of the American Bar Association was, “Complexity is needed so that you can pay less taxes.”  But, to those interested in real reform, the obverse rings with more truth – “We have complexity so that we can have a system with high tax rates.”

[3] Proposals for a new and different tax system typically come with their own person-tax features. The Fair Tax, for example, provides for families to file annual applications to obtain their Fair Tax rebates.

Moreover, often over-looked in these proposals for repeal of the income tax, is that a repealed income tax might later be re-enacted. If so, this would result in the country having two major taxing systems providing expanded funding to grow bigger government.  To prevent re-enactment, a Constitutional amendment would be required to specifically prohibit re-imposition of an income tax.

Recognizing such an amendment improbable and viewing a true income tax possible, the FreedomTax would continue the income tax (the tax we already have) and rectify its fundamental flaws.

[4] The current income tax is structured under self-assessment and direct levy of the tax on persons.  As such, it appears to constitute direct taxation in violation of the Constitution’s ban against a direct tax unless it is apportioned among the States (Article I, Section 2, Clause 3) or levied in proportion to the Census (Article I, Section 9, Clause 4).  The 16th Amendment is the only exception to this prohibition.  It provides, “The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” (Emphasis added).  Literally read, the 16th Amendment authorizes levy of the tax only on incomes, not persons.   (Tailored to the 16th Amendment, the FreedomTax would make the tax a levy on income.)

Indeed, there are those who might argue that the income tax is not a direct tax at all, but rather is an indirect excise tax with no need for 16th Amendment authorization.  Undercutting this argument is the convoluted nature of the tax, which would put it in violation of the Uniformity Clause.  Section 8 of Article I of the Constitution requires that all excise taxes “shall be uniform throughout the United States.”  “Uniform,” the income tax is not.  Its imposition on income varies with the payor, by whom received, and use to which put.  Moreover, in too many cases, income is not taxed at all, but when it’s taxed, the rate of taxation is varied under arbitrary rules (e.g., based upon the amount of other income received and the allowance of deductions and tax breaks having nothing to do with income production).

[5] Tax expenditures compromise government spending priorities. The lost tax revenue represents billions in program spending independent of the regular Congressional budget process, and encumber Government funding otherwise better spent on programs having higher priority and/or more efficacy.

[6] Many of these tax breaks are in the Tax Code to serve as personal taxpayer shields against high-rate taxation, their value greatly reduced in a low-rate environment and rendered unnecessary under the low-rate FreedomTax.

[7] To function, this system requires more than 70,000 pages of tax law, tax regulations, tax rulings, and other materials, requiring more than 500 tax forms. And, the IRS is dependent upon tens of thousands of employees and an annual budget of over $13 billion to run the system.

[8] About this, the TCJA (the latest floorboard nail) makes matters worse.  It leaves partners and other pass-through entity still required to report and pay the tax on their share of pass-through-entity business income.  By continuing the different-rate taxation of business and individual income, the TCJA has been forced to add more tax rules to maintain this tax separation of business income from individual income, furthering tax-law complexity.

[9] The FreedomTax Plan is intended to be revenue neutral.  It was initially proposed with a 10% tax rate in order for the Plan to be seen as a serious, low-rate tax-reform plan that would raise at least as much tax revenue as the then-existing tax system.  [It was proposed before enactment of the TCJA, which reduced the tax rates and tax revenues of the old system.]  The key point is that the FreedomTax, at a 10% tax rate, will raise more tax revenue than the tax system as it existed before the TCJA.  When the Plan is officially revenue-scored, this 10% rate is expected to be set lower, likely much lower, for the FreedomTax to be actually revenue-neutral.

In this regard, there’s the 2005 study of the well-respected Tax Foundation, suggesting a 9% flat-tax rate (for the old existing system).  This study concluded that if the then-tax base (in 2005) were expanded to include all income, the marginal income tax rates could be markedly reduced.   In particular, it found that the study’s all-inclusive tax base would allow for a flat tax rate of 9 percent.  The study was published by the Tax Foundation under the title “America’s Shrinking Income Tax Base Requires Higher Rates for Everyone” and was authored by Patrick Fleenor and Andrew Chamberlain and included a fact sheet, Special Report No. 135 (September 21, 2005).   See http://taxfoundation.org/sites/taxfoundation.org/files/docs/ff-20050921.pdf 

As to a FreedomTax rate lower than the Tax Foundation’s 9%, the income tax-base expansion in the Tax Foundation study is much narrower in scope than the tax-base expansion proposed under the FreedomTax (discussed in element #2 below).  The Tax Foundation’s narrower tax base suggests that the FreedomTax could raise the same tax revenue with its tax rate set lower, perhaps much lower, than the Foundation’s 9% rate.   [And, looking at the tax revenue expected under the TCJA, the FreedomTax rate might be set even lower and still match a TCJA tax-revenue benchmark.]

[10] Some tax reform plans claim to be flat-tax proposals, but, they are single tax-bracket plans, not designed to tax all income the same and at that same flat rate.  Under these “flat-tax” plans, the tax is applied to the extent the taxed-person’s income exceeds a single tax-bracket amount.  And, they all are proposals still calling for personal returns to be filed, leaving the tax system still structured for the later addition of more and higher tax brackets.   [Indeed, the existing tax system functions with multiple flat taxes, each applied after the tax bracket below it.]

[11] This includes employer-paid health and life insurance premiums, employer-and employee-paid contributions to retirement plans, plus the employer-paid portion of the employee’s FICA taxes (not now subject to income tax, but which like the employee-paid portion now income-taxed, are contributions made on behalf of the employee for his retirement).

[12] With elimination of the personal income deductions and exclusions for contributions made to Pension Plans, Section 401(k) plans and IRAs, the FreedomTax would also include in the tax base all income earned inside those plans with respect to the assets held by those plans.  This means that the payors of dividend and interest income into those plans would apply the same at-source tax withholding rules already discussed.  Similarly, the “income build-up” in life insurance policies would be currently taxable with the insurance company responsible for at-source tax withholding and payment.  Accruals to these arrangements would be net of tax, meaning that distributions from these arrangements, when made, would be already-taxed and tax-free to the recipient.

[13] Charities would have their dividend and interest income subject to the at-source tax withholding rules already discussed.  In the case of income from any businesses they carry on related to their charitable purpose (now exempt from income taxation), they would file business tax returns to report and pay the tax on this business income, as would all other business taxpayers.

It must be noted that gift contributions and bequests to charities would continue to be treated as gifts, not income to be taxed.  Donors would be free to make gifts to charity without having this reported to the IRS, and charities would be free to operate in any manner consistent with their purpose without any tax second-guessing from the IRS on how they operate.

[14] Repeal would include the refundable Earned Income Tax Credit (EITC), which represents very poor tax policy.  Popular, but dubious, it’s an embedded feature of the income-tax system, undermining the tax’s purpose to raise revenue.  Not only does the EITC erode this revenue-raising purpose, it functions as a welfare program left on auto-pilot and shielded from Congressional oversight via the budget and appropriation process.  It has a perverse effect on the goal to return people to work and to move them up the economic latter.  Its phase-out feature reduces the amount of the allowed credit as the taxpayer’s total income increases, exposing those relying on the credit to the disincentive effects of high-tax rates.

[15] Excluded would be the payment of Medicare benefits.  As under present law, these payments are not income.  Medicare is structured as an insurance program for which participants pay premiums in the form of taxes, thereby becoming eligible for the benefits. Medicare falls in the same category as the benefits paid out by private insurance companies to reimburse for incurred medical expenses, casualty losses, and loss of life.  These insurance payments compensate for losses sustained and thus cannot be income to the recipient.

[16] As discussed above, the FreedomTax Plan is a proposal for the clean-up of the Tax Code mess and for principled income taxation.  It’s to have a true income tax applicable to all income, without exceptions.  With this goal in mind, it’s NOT a plan intended to undermine Government programs, nor does it need be.

Consider relief programs now dispensed in what amounts to tax-free income to those in need.  These programs are authorized and funded by Congress. Upon enactment of the FreedomTax, Congress can be expected to gross-up to the administering agencies the additional funding required to cover the withheld income tax, avoiding payment-diminution to the recipients.  Moreover, gross-up would achieve better inter-agency accounting, causing the full cost of Government programs to be included in the responsible agency budgets, rather than being partially hidden in the form of lost tax revenue to the Treasury.

[17] Despite its curtailing many business tax breaks, the TCJA adds a new major tax break to allow the cost of new business investments to be deducted as an expense in the year when made, rather than required to be depreciated and expensed over the investment’s useful life.  Again, high tax rates give value to tax breaks and, with the TCJA leaving rates still too high, this new break might be justified as a necessity to counteract the adverse effect that high rates have on after-tax investment returns.   [The reader’s attention is directed to this same point made in broader context in endnote 40.]

[18] Universally ignored and impossible to overstate, good fiscal management of public funds is compromised, to have embedded in a revenue-raising system, a helter-skelter universe of provisions each operating independently to forgive the collection of revenue.

[19] Other cases where individuals would be freed of their return filing and tax payment responsibility would include income from life annuities and Social Security retirement payments.  As discussed above, distributions from partnerships, trusts, and estates also would not require any return filing by the recipient.  What these entities distribute to their recipients will have already been taxed.

[20] At-source tax withholding and tax payment would apply to all dividend and interest income without regard to the recipient and would apply in the case of tax-exempt entities and foreign owners of U.S. debt and stock.  Because foreign stock and bond ownership is high, the system would result in be a significant pick-up in tax revenue, but as is common today, foreign countries likely will negotiate tax-treaty relief for their citizens.

[21] Their filed business tax returns would exclude all of their other income for which the tax will have already been paid by reason of at-source taxation.

[22] In the case of life annuities, the payor would withhold the income tax, but doing so in recognition that the gross amount of every payment is not always the measure of the annuitant’s income.  The payor, having the record of the purchase price paid (or tax basis) of every annuity, will commence income-tax withholding on the payments being made once the annuitant himself reaches the point of being in receipt of “income” from the payments; i.e., when his receipts at that point exceed the acquisition cost of his annuity.  Retirement payments under Social Security would receive the same treatment.  Here, the Social Security Administration would have, or should have, the record of all the FICA taxes paid by each recipient (and by his employer on his behalf), and it will commence withholding when the recipient first realizes income from the program.  The FreedomTax deliberately rejects use of a life-expectancy method to determine taxability of every annuity payment (under which the recipient’s annuity cost would be apportioned to the payments expected over his lifetime), and instead would employ the simple cost-recovery method, requiring his annuity cost to be fully recouped from his first payments before at-source taxation commences with respect to the following payments.

[23] So, customers paying for goods and services, and tenants renting, would have no withholding or tax payment responsibility when they purchase goods and services, nor would tenants paying rent.  Businesses and landlords have business expenses to take into account, this requiring them to file business tax returns and have the tax-payment responsibility.  Similarly, borrowers paying interest to lenders would have no withholding responsibility because the lenders, such as banks and credit unions, would be paying the tax on their business income.

[24] This reform would fully eliminate the current tax-law’s bias in favor of leveraging companies with debt rather than financing with equity.  The TCJA deals with this bias in the anti-reform way of creating the double-tax situation for corporate interest expense, to mimic that of dividends. It restricts a corporation’s deduction for interest expense when the corporate indebtedness exceeds accepted TCJA levels.   [Corporate income used to pay interest expense and made taxable to the corporation amounts to double-taxed income to the lender, just as dividends now are to the shareholders.]

[25] At-source withholding and taxation would not apply to dividend distributions made inside a consolidated group of corporations.  The FreedomTax would continue the current provisions related to the consolidated-tax-return reporting of companies with controlled subsidiaries, where intra-group transactions are eliminated and the consolidated group is treated for tax purposes as if it were a single corporation.   [It should be noted that the single-rate taxation of all income, the integration of the business and individual income taxes, and the capital-gain-tax reform discussed below, allows for the elaborate tax provisions related to corporate reorganization and other corporate transactions to be greatly simplified.]

[26] The history of taxing capital gains as income stems from a dubious, and at the time much criticized, Supreme Court decision, Merchants Loan and Trust Co. v. Smietanke, 255 U.S. 509 (1921), reversing prior Supreme Court decisions holding capital gains not to be income.  See Bruce Bartlett, “Why the Capital Gains Rate Should Be Zero,” NCPA Policy Report No. 245 (August 2001), at www.ncpa.org/pub/st245.  Indeed, capital gains (outside the business of trading in capital assets, such as the trading in stocks and bonds) are not considered by economists to be income when they compute GDP because capital gains are not income in the economic sense.   See https://www.quora.com/Why-are-capital-gains-not-included-in-GDP .

[27] Analogous to the taxation of capital gains as income would be the taxing of the increased earning power of a worker changing to a higher-paying job, his gain measured by the extent the value of his earning power from his new job value exceeds the value of his earning power from his old job.

[28] Existing tax law draws this same distinction.

[29] An example of this would be the rules creating “phantom” income and expense under the imputed rent and imputed interest provisions found in IRC Sections 467 and 483.  Another would be the special capitalization rules for inventories under IRC Section 263A, requiring taxpayers to keep an additional set of inventory records for tax purposes.   A reform goal of the FreedomTax is to reduce the need for businesses to keep separate records for tax purposes, and to move the IRS back in the direction of allowing businesses to use the same books and records and accounting methods as are employed to run the business.

[30] See Costs and Consequences of the Federal Estate Tax, Report of the Joint Economic Committee, U.S. Congress (May 2006), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=906812 .

[31] Including inherited property.

[32] The TCJA raises the estate and gift tax exemptions only for eight years until 2026 and leaves these taxes fully in place, still with impact on business decisions for estate-tax planning purposes.

[33] Most of these provisions would be repealed, including the foreign tax credit rules applicable in cases where a foreign country is taxing the same income the U.S. is taxing.  But, for instance, the existing rules under IRC Section 482 would be continued to assure arms-length pricing of transactions between a U.S. business and its operations abroad to prevent the shifting of U.S. income overseas. Nevertheless, low-rate taxation will remove much, if not all, of the incentive to engage in tax-shifting arrangements.

[34] See Dittmer, Philip, A Global Perspective on Territorial Taxation, Special Report No. 202, Tax Foundation (August 10, 2012), at http://taxfoundation.org/article/global-perspective-territorial-taxation.

[35] Nor should the earnings of U.S. individuals employed abroad be subject to U.S. taxation.

[36] In failing to end worldwide taxation, the TCJA seems directed at evening the decision between the retention or repatriation of foreign earnings, by having essentially the same tax rate either way. The Treasury no longer needs to wait for a repatriation to gain tax revenue.

[37] There’s another instance where the TCJA architects were called upon to make an adaptation to our disheveled tax system.  As already discussed in endnote 25, the TCJA added a special limitation on the deductibility of corporate interest expense.  This was to help solve a tax-bias problem that never would never would have existed had the tax system been designed and structured as a single-rate tax system under which all income is taxed the same and only once.

[38] The FreedomTax, with its low rate of taxation uniformly applied to all income, would be a more democratic tax system and foster a more common perspective among voters regarding our nation’s fiscal affairs.

[39] A tax regime of low rates obviates all need for special tax incentives to make attractive saving and investment. Consider these figures for comparison purposes:  Under the present system, if income is to be taxed at say 28%, this leaves only 72% to be invested. A 5% return on that 72%-investment would yield 3.6% after-tax (relative to the initial pre-tax amount of the income invested).  But, under the FreedomTax, income taxed at 10% would leave 90% to be invested, and the 5% return on that would give the saver or investor an after-tax return of 4.5% (a 25% higher after-tax return).

[40] It’s a ruse to contend that those now shielded from the income tax, but who have FDIC taxes and Medicare taxes deducted from their wages, are paying the income tax (because these taxes are based upon the amount of their wage income).  These payments, called “taxes” for collection purposes, are measured contributions to specific insurance programs run by the Federal Government for the benefit of the individual worker.  When credited to his individual account in the program, these program taxes accrue him a contribution benefit.  By contrast, the income tax paid on wage, interest, and dividend income does not earn the taxpayer any benefit in his individual Social Security or Medicare account.