Tax & Accounting News
Progressive, Flat and FairTax Explained | Thought Leaders Interview
The following interview of Lee Reams Sr. took place on Monday August 18, 2015. Geared toward taxpayers, the interview is meant to clear up some of the tax reform proposals being discussed at the start of the 2016 Presidential campaign.
Lee Reams:
Thank you for joining me today. My name is Lee Reams with TaxBuzz and today we're going to talk about getting to the bottom of the Tax Reform Proposals. We're going to go through the Progressive, Flat, and Fair Tax. This is part of a series of our Thought Leader Series that we run through TaxBuzz on our blog, and we try to meet with people who give us some different insight and different point of view on the way our tax system works, different tax reform, proposals and kind of what's on the horizon.
Today we're joined by Lee Reams, Sr., one of tax experts and Editor and Chief at TaxBuzz.com. Welcome Mr. Reams, how are you doing today?
Lee Reams, Sr.:
I'm doing great, thank you, how about yourself?
Lee Reams:
Very good. Before I get into the questions here I kind of want to give a little bit of feedback or summary on why we're meeting and kind of the insight I would like to give to your viewers.
The first issue is obviously with the 2016 election cycle in full bloom there are a number of Republican candidates right now, the debates were very recently done. You're hearing a lot of noise out there about tax reform. Local surveys and even some national ones that have come out in the last few days have said that the business side of things, as far as CEOs of companies believe that the chance of tax reform happening even before 2017 is actually gone from the high 50s to low 40s. The more they talk about it, it seems the more people feel that it won't happen. I still think it's important that tax payers understand what the current progressive policy is and really get an idea of when people say "flat tax" and "fair tax" what they're talking about.
Let's start out here, if you could, please tell me a little bit about a progressive system. The way it was designed to work and the way it's kind of evolved to what we have today.
Lee Reams, Sr.:
Our progressive system is based on taxing the lower income people at the minimal amount, and then as your income increases they keep raising your tax rates, and so on, until you get to the top company people making the top rate. Basically 10% of all taxpayers in the United States pay 90% of the taxes, where on the flipside of that 1/3 of the taxpayers in the United States, that's those with the lowest incomes actually pay no tax at all. They receive refundable credits and other benefits that actually give them money back instead of paying taxes.
Lee Reams:
Would you say the complexity of the progressive system, in addition to all these different credits and other things that the traditional progressive tax if left alone everybody would be paying taxes at that point, and it's all these deductions and kind of the special interest in some way that perhaps have kind of changed the progressive system to what we have today? Is that a fair assessment?
Lee Reams, Sr.:
That's a fair assessment, yes. Every year they keep tacking on more and more changes and adjustments, it just keeps getting worse.
Lee Reams:
Okay, let's turn now to the Flat Tax. Explain to me, we've heard some different tax rates that are being floated around, but let's get an idea of what kind of rates are people talking about in the flat tax, and exactly how would a flat tax work?
Lee Reams, Sr.:
If you took a true flat tax, everybody would get taxed at the same rate on all their income. What we've heard from most of the politicians, it's ranging from 12-20%. Regardless of what you make you would pay that flat amount, but that may not work in the future because of people who right now receive other benefits, they would take those away from them.
Lee Reams:
Wouldn't that create a larger tax for low income individuals than what they are paying today?
Lee Reams, Sr.:
That's a very good observation, that's why a true flat tax has never come along. It's going to be a flat tax with adjustments and extra benefits and credits, stuff like that. Yeah, this will work in our current system that we have now.
Lee Reams:
You've kind of alluded a little bit to what you call a "social control system". Explain to me what you mean by that, and kind of go back to the one thing you didn't say, there's actually a huge tax reduction for higher income individuals that they're now paying in the high 30s and more with different Affordable Care Act rates in there. Explain to me what you mean by "social control system".
Lee Reams, Sr.:
Let's say Congress wants people to put in solar system to generate electricity, well they generate a credit to do that. Say they want people to get off of welfare and go to work, then they add in what they call the earned income tax credit. So the lower income people who are working for a minor wage will actually get extra money given to them through the tax system to bring that up, that's called the earned income tax credit. Then years ago they wanted everybody to own their own home so they gave them an interest and tax deduction on their home mortgages and their home taxes. All these kinds of things they add to the system to essentially do their bidding, the Congress' bidding. Now we have a premium tax credit to get people to buy insurance through their marketplace, so all these are incentives to do what the government wants you to do.
Lee Reams:
Your observation here then is some of the challenges with any tax reform would be how do you get the special interest and the lobbyists out of the process, and I would kid of segue that into if there's a big tax reform change how do they guarantee that it's a revenue neutral changeover? Meaning, the biggest fear is for the government at least and maybe it would be great for the rest of us taxpayers is they used to have a system that generated $2.7-trillion in taxes and now they have a system that's $400-$500 million short. That's obviously going to create a huge problem with our borrowing and budgets across the board, but kind of share with us your thoughts on those two issues.
Lee Reams, Sr.:
The top 10% of the taxpayers pay 90% of the income tax, so a 20% rate would represent a substantial reduction for them because they are in excess of 39% of the top rates, so they would love that. Now the tax policy sent out of the Brooklyn Institute recently reviewed Rick Perry's flat tax proposal and said it's going to reduce American's tax liability by $995-million. That's about 27% out of the tax revenues for the nation. That certainly is not going to work. They are looking for more revenue not less, and this isn't really a flat tax in the first place, it's a hybrid. We're going to have a 20% flat tax but we're going to allow home mortgage and taxes to be deductible, allow charitable contributions as income tax deductions, and then he does more to tax Social Security Income and long-term capital gains. One end the Social Security is taxable, that's helping the low income people on Social Security, but what about the long-term capital gains for these big Wall Street gentlemen?
There's some interesting things in that.
Lee Reams:
Obviously I don't think it would fly with the 27% reduction in tax revenue, so I think people could argue that economic activity would be higher, more people would be hiring and perhaps as incomes rise the tax base would increase, but that's kind of a counter to that. No matter what it's a risk key endeavor, $995-billion is a huge number.
Let's kind of change up then and get away from the flat tax to something that most people have not heard about and that's the Fair Tax. I would tell people to go to fairtax.org if you want to read up and see more details, they have some research there that kind of goes through it.
Give me kind of an overview, basically it's a nationwide sales tax, but give me some insight on how these taxes would be collected.
Lee Reams, Sr.:
The fair tax as it's called eliminates all the payroll taxes and the income taxes and would replace it with national sales tax at 23% on both goods and services. Now before services were not normally included in sales tax, so let's take an example. Say you go out and buy a shirt for $70 that you would normally pay $70 for, add a little bit of state income tax, but now with the 23% tax built into it that shirt is going to cost you not $70 but $86.10. It's going to add $16.10 of federal sales tax and then think about if you go out and get your hair cut, costs you $20 they're going to charge you sales tax on top of that, too.
Lee Reams:
The fair tax people are saying that overall, since your income is not being taxed you're going to actually have more money in your pocket, so maybe paying an extra $16.10 for your haircut isn't that big of a deal. One of the things I wanted to lead into is I don't know how you would have a national state and local tax. I know the fair tax in reading about it wants to abolish the IRS, so I'm just throwing this out, I'm sure you don't have an exact answer. If there is no IRS, there's got to be somebody that's auditing this, there's going to be someone who is managing some of the things I think you're going to get into as well with the prebate. Explain for us since we're talking about prebate, what are your thoughts on the prebate and secondarily how would without an agency to manage revenue, exactly what is the game plan there?
Lee Reams, Sr.:
Number one, somebody has to collect the tax. Somebody has to pay the rebates, and somebody has to make sure the prebates are based upon the actual income. The IRS isn't going to go away, the IRS if they have this fair tax, as they call it, they're going to start administering the fair tax instead of the income tax. It's the same difference, it's just proposals that people don't think all the way through and I think sometimes they do it during election season just to get elected.
Lee Reams:
I guess we will see soon enough, right. Let's then talk, I did ask a little bit about the states, but how do you think the states would be involved? We're here in California so we obviously have a very high sales tax rate. There's local taxes on there as well, and then there's income taxes and property taxes and all kind of things. I was trying to figure out, just kind of reviewing it, would the fair tax assume that all states then abolish their income tax and would the sales tax be on top of the national tax and the local, and then what would they do with the income tax? Otherwise it seems it would still be a somewhat complicated deal when you're doing your taxes.
What are your thoughts about the states and how they would be involved?
Lee Reams, Sr.:
The states are not going to get off their sales tax revenue, they live off of that, plus local communities do that as well. Obviously they are going to give up their state income taxes. You go to someplace like Texas doesn't have a state income tax, but then the property taxes are gigantic. They are paying the tax one way or the other, it's just an interesting case. If they actually had a fair tax, they would say if you were in California, you have around 8% state tax prebates, now you add the state to 23% federal and that's a 31% tax. A hair cut would go up $26.20.
Lee Reams:
I guess these are the questions that need to be addressed or answered, and we're hoping to get policies from the candidates as they go through. I know again some of these details are there and some of them use some older details, but I think these are valid questions in today's market.
That kind of brings me into, do you think there would be a fear on your side that we would get an underground economy because the sales tax rates would become so high. Would people just start paying in cash and somehow try to hide it?
What are your thoughts about that?
Lee Reams, Sr.:
Well they're doing that now with income tax, so I don't know how this is going to correct that situation. Hypothetically if tax is collected on everything you buy, you pay sales tax, you're going to go buy groceries or you're going to buy a car, you go buy some clothes at the store, you're going to pay some tax. But now comes a time when you're dealing with a guy who provides services, like the contractor who fixes up your house or your gardener, somebody like that, they're going to say just pay me cash and forget sales tax. So it's the same thing you have going on now for services.
Lee Reams:
I guess just on a larger scale obviously. The incentive is there not to hide it, that's for sure, that's a serious percentage. I guess people would have more money is the argument, but that's an interesting question and it could be debated as these policies are looked through it.
Going back to this abolish the IRS and pound on the IRS. Right now we know Congress has taken a lot of money out of their budget, the Obama Administration is actually trying in the next budget to increase the funding back for the IRS.
With everything they're saying, let's abolish the IRS. It's an easy, easy target. What is your thought process on that? Is that something that will happen in the near future or perhaps 10, 20 years from now?
Lee Reams, Sr.:
No matter what tax system we have, everybody is going to try to cheat it. Not everybody but we have a large number of people who think that's a fair game to play this day in age. The IRS stands for the Internal Revenue Service, and income tax and consumption tax are both internal taxes so why would the IRS continue to collect the national sales tax and enforce its provisions. I don't see why it would.
They aren't going to get rid of the IRS, they're just going to change what the IRS is doing.
Lee Reams:
Right, and then the way the lobbyists and the politicians work, would probably start adding complexity to whatever change plan that we see.
I guess one final question for you, do you think the lobbyists and outside influence ever will give us a simple fair system?
Lee Reams, Sr.:
Well that's a really loaded question. If the lobbyist's job is to influence government action in favor of special interest they represent, so I think you know the answer to that question. They're going to continue to do that and there's not much you can do about it. The only way to get rid of that is to ban lobbyists.
Lee Reams:
Alright, that's going to be the summary of this, is ban lobbyists and it will fix all of the problems. We don't have to change the tax code at all, it's let's ban the lobbyists and Washington will clean up its act.
Thank you very much for your time today, I really appreciate it and we'll come back to you with any follow up questions from our viewers.
That will wrap up our Thought Leader interview today here on Tax Reform Proposals, again the progressive, flat tax and fair tax.
Thank you!
Lee Reams II
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