The current income tax system is always under attack. Some people want to switch over to a flat rate and others want to scrap the entire system altogether. The question is, should the system be scrapped because it is unfair to rich people, because it's confusing, or because there is a better way to raise revenue?
In the order that the above questions were asked, the answers are: no, yes, maybe. Rich people are not punished by the income tax system; they benefit from it the most. The income tax system is confusing and there may be a better way to raise money for the government.
Who Does the Income Tax Affect the Most?
The income tax is levied on people who earn their income and not those who have their money making money for them. This means that the richest people, such as Warren Buffett, Steve Jobs, and Christy Walton, do not pay income taxes. Rather, they pay capital gains taxes, which is currently 15%.
Interestingly enough, 15% is also the rate that the lowest wage earners pay as well. This is where the people who have a problem with the income tax have a legitimate complaint. The highest income earners pay 35% of every dollar over $373,651 in taxes before FICA/Medicare get taken out, meaning that people who are earning a living end up with slightly less than half of their money after a certain point, but people who may have never worked a day in their life keep 85% of every dollar, even if their investment income is $1 billion.
Many low income earners do not pay income taxes at the end of the year because their taxable income after credits and exemptions ends up being $0, so they get their withholdings back along with any credits, such as the Earned Income Tax Credit or the Adoption Credit.
It is as a person makes more money from his or her effort in a career or business that he or she pays more in taxes, but if a person receives money from investments, the taxes are significantly lower.
The Tax System in Confusing
Most people do not understand the tax system. For example, the rates are on a tiered system, which means that up until a certain amount, people are taxed at one rate. This means that if a person is in the top tax bracket of 35% (in 2011) because he earns $500,000, that tax rate only applies to the $126,349 over the limit. Every dollar below that is taxed at a regressively lower rate.
More people would understand this if the law didn't change every year and wasn't so extensive that no one was able to actually read all of it in the one year that it actually applied to them. However, if there is no better solution for the current system, all people can do is complain, and that is a waste of time.
The FairTax and the Flat Tax
There are two major reform ideas that fiscally-minded citizens want to see replace the current income tax system. One is called the FairTax, which is a national retail sales tax, and the other is the Flat Tax, which is an income tax rate that does not rise or fall with income.
The Flat Tax is great in that it reforms the major parts of the income tax system. However, the most recent bill proposes a 15% tax on all earned income and 0% tax on capital gains. This means that CEOs and lesser executives who can elect to take all of their salary in dividend-paying stock would pay no taxes on the potentially millions of dollars they receive while everyone beneath them would pay into the system, effectively receiving less than they actually earn.
The FairTax, which proposes to add a national sales tax of 30% ($77 of goods will cost $100) to all goods and services, will allow every person to take all of their income home. When they spend money, they'll pay into the tax system, but never any sooner than this.
Along with normal income earners paying into this system, so will those who live off of capital gains, but they will not be alone as they are right now. Joining them will be people who do not currently pay taxes on the money they make, such as drug dealers, pimps, theives, strippers, illegal aliens, and anyone else earning income they do not report.
With the Flat Tax, the richest people literally pay no taxes while the FairTax taxes everyone. Those with more money to spend will pay more into the system under the FairTax while the Flat Tax only collects from those who have earned income. The conclusion is that the FairTax is better as a basis of levying taxes because it will raise more money from more people (to include those who don't currently pay taxes because of cash businesses and illegal activity) while the Flat Tax will collect less taxes from less people beause of the lower rate and exclusion of the wealthiest people.
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