Article I, Section 8 of the US Constitution has vested power in the federal government to collect taxes in order to pay debts, provide for the common defense, and promote the general welfare. With this power, the federal government must clearly define the goals of effective tax policy. The USA is a diverse country with over 350 million citizens from all different backgrounds and differing worldviews. So, effective tax policy must be focused on these three specific goals defined within the Constitution. Yet, none of them is universally agreed upon.

The first is to pay debts. Most citizens can agree on this goal. However, the amount of debt to accumulate along with the specific items within the federal budget worthy enough to utilize deficit spending can hardly be agreed upon.

The second goal of common defense is widely understood as necessary, yet the degree of this spending is also a point of great contention.

The third goal, promote the general welfare, is where effective tax policy finds its most complex challenge. This goal is hardly defined within the Constitution; hence, it is open to a diverse array of interpretation. One might argue, the ambiguity of this goal is purposefully crafted, so that the challenge of effective federal tax policy rests in the zeitgeist of the times.

    The USA is widely regarded as a “free” society. Within a free society, where individual rights are thought to be valued, any power that is given to government automatically infringes on the rights and powers of the individual. This understanding of opposing forces needs to be taken into account when creating a framework to define the term that was set as the largest challenge in crafting tax policy, to promote the general welfare of all citizens.

Thomas Jefferson wrote an opinion seeking to define the ability of the federal government to promote the general welfare. Jefferson states, “laying of taxes is the power, and the general welfare the purpose for which the power is to be exercised. They [Congress] are not to lay taxes ad libitum for any purpose they please; but only to pay the debts or provide for the welfare of the Union. In like manner, they are not to do anything they please to provide for the general welfare, but only to lay taxes for that purpose.”¹ 

Jefferson was of the belief that the general welfare extends only to the specific powers enumerated to Congress in subsequent sections of the Constitution.

An opposing view put forth by Hamilton, who “maintained the clause confers a power separate and distinct from those later enumerated, is not restricted in meaning by the grant of them, and Congress consequently has a substantive power to tax and to appropriate, limited only by the requirement that it shall be exercised to provide for the general welfare.”²

In short, Hamilton believed the clause defining the general welfare was a specific power beyond those elsewhere enumerated. Within these opposing views, one may see the challenge in defining the goal of promoting the general welfare.

The Progressive Flat Tax

 Long-Winded Discussion....

A tax policy that within its very name holds an oxymoron is a classical way to satisfy the opposing worldviews inherent in the very founding of our nation.

In a free society, the fruit of an individual’s own labor should be retained by that individual to the largest extent as possible. This is the foundational principle that allows a progressive tax to be applied in conjunction with a flat tax. Labor, wages, salary, and in a broader sense, earned income needs to differentiated from unearned income.

Income that is earned through the work of an individual is sacred. If all men are created equal, as the founding documents make claim; then, it goes to follow, all work/labor of that individual should be taxed at the same rate by the federal government. This goes to the equal protection under the law clause and is combined with the differentiated income tax rates applied to income earned in any other means, beyond that of direct work/labor. This is the key to the Progressive Flat Tax.

Current US tax policy applies a “flat” tax on the payroll of individuals and businesses, yet exempts income earned over a set threshold with that threshold increasing for inflation annually. This flat tax rate is set at 7.65% on the individual side along with an additional 7.65% on the business side of the payroll. This 15.3% flat tax does not allow for exemptions and generates 36% of all federal revenues based on Tax Year 2019. Compare that fact to the 50% of federal revenues collected from the complicated progressive individual income tax system that allows for exemptions and differing classifications of income.

Even though the payroll tax is flat, it is actually a regressive tax since non-wage earners are also the wealthiest individuals and they are exempt from this tax altogether.

Concurrently, high wage earners are only taxed up until a certain level, the Social Security Wage Base. They are exempted on the marginal income beyond the threshold. The Progressive Flat Tax applies this theory of a flat tax to all income earned through wages regardless of the income level. There is no exemption above a certain threshold.

The Progressive Flat Tax rate on income earned through wages/labor/work will be a flat 10%.

This is combined with a flat 10% payroll tax paid by the employer. The standard exemption of $12,400 for each filer in 2020 and indexed for inflation is the only exemption on the individual side. There are no other exemptions nor deductions on this flat tax rate for wages earned.

For the largest percentage of citizens, this is a net decrease in effective taxes paid. 

Society creates wealth.

Some individuals are able to benefit from the wealth that society creates more than others. To the extent that some individuals are able to reap the rewards of a growing society more than others, this gain is able to be taxed progressively.

The US tax policy currently taxes unearned income, such as capital gains, at a flat rate. This is a loop-holes baked into the US tax system that benefit the wealthiest citizens earning income from the wealth and growth of society at-large, as opposed to the fruit of their own labor.

This allows the wealthiest in society to bring a stated income tax rate of 43.4% to an effective income tax rate of 24.7%¹⁰. Most of this income is also avoiding the 7.65% payroll tax along with businesses avoiding the 7.65% business side payroll tax.

The Progressive Flat Tax policy progressively taxes unearned income at the lowest rate of 20%, equal to that of the combined business payroll tax and flat earned income rate. The marginal tax rate on unearned income increases at $250,000 of combined earned/unearned income for single filers, $500,000 for married filers.

At that level, the marginal tax rate increases, on unearned income only, to 40% from 20%.

The next highest marginal tax rate on unearned income is for individuals earning more than a combined earned/unearned income level of $1,000,000 and for married couples earning more than a combined $2,000,000.  This marginal tax rate on unearned income is 47.5%.

The highest marginal tax rate for single filers unearned income is for individuals earning more than a combined, earned/unearned income level of $10,000,000 and for married filers, earning more that $20,000,000. This marginal tax rate is on the unearned income only and is taxed at 57.5%.

This rate above 50% is justifiable, as the Corporate Tax on business income is 0%. All income tax is being paid by the individual that owns the shares, based on their own individual income situation. 

The current tax system that taxes corporate profits at the corporate level is actually another regressive tax policy. Under the current law, Lower-Income and Middle-Income shareholders are paying effectively paying the same tax rate on corporate profits as the wealthiest income shareholders.

The Progressive Flat Tax solves this issue by taxing corporate profits at the shareholder level only.

An argument against a progressive capital gains tax is that in a given year, such as the one-time sale of a long-term asset, a taxpayer might “look” wealthier than they actually are.

The current capital gains exemption for Primary Residenceis the only exemption that remains unchanged. However, when there are costs associated with generating that unearned income, those costs can be written directly off the income, similar to running a business Profit & Loss statement. Examples of these expenses are advisory fees, account fees, closing costs, etc.

The Progressive Flat Tax also allows for all tax brackets to spread out their capital gains income over a maximum of 5 years going forward. This will allow a windfall sale, for example a small business, to not adversely affect the income of lower wage earners.

However, income earners that extensively earn income from capital gains will pay the average income they make over the course of multiple years.

There are no distinctions for long-term capital gains and short-term capital gains. The exemption for the sale of a primary residence remains the same as the current rules.

By combining a flat tax with a progressive tax, the Progressive Flat Tax is able to appease the desires of competing worldviews.

By utilizing the historical data from the US tax system, the Progressive Flat Tax will mirror the revenue of current US tax receipts, while at the same time lower the effective tax rate of the majority of citizens, broaden the tax base, and create a more equitable tax policy that promotes economic growth and work.

As all men are created equal, the wealthiest among us will pay an equal tax rate to the poorest among us when they work for their wages. Yet, when society at-large creates wealth for an individual, that income is capable of being taxed progressively to even the score of society's unequal outcomes.

The Progressive Flat Tax has a few other features that allows this tax policy to be both Pro-Growth and Pro-Labor.

As it stands, corporations have three options on what to do with their profits. They can buyback shares, pay dividends, or reinvest in their business. The current US tax system taxes corporations with a complicated tax code. Yet, all that policy only generates 7% of total federal revenue.

The only option for corporations is to either return profits to shareholders through dividends or buybacks, and that is taxed in a progressive manner to the shareholder.  Or, the corporation can reinvest in the business, which creates conditions for a growing economy.

The Progressive Flat Tax removes all corporate taxes.

This is simultaneously removing an excessive cost of accounting for businesses, while at the same time, shifting the focus to growth and taxing the income to the individual that actually earns the profit at a tax rate that matches that individual’s income/wealth situation.

A wealthy shareholder is taxed on the corporate profits at their proper rate, whereas a modest income earner shareholder is taxed at their proper rate.

This is combined with the removal of one of the largest loopholes to capital gains, the removal of step-up in basis at death. The current estate tax system allows for all unrealized capital gains of a decedent to evaporate. This is a loophole in the current system that exasperates wealth inequality by allowing capital gains to pass to heirs without any tax being due on the growth society at-large contributed to.

Under the Progressive Flat Tax, the estate/death tax is completely removed. All assets are valued at death and all unrealized capital gains are realized with taxes paid before transfer of assets occurs.

^1,2 CRS Annotated Constitution; Scope of the Power. Retrieved March 11^th, 2017 from

https://www.law.cornell.edu/anncon/html/art1frag29_user.html

 ^3,4,5,9Sources of Total Federal Tax Revenue. Tax Policy Center. Retrieved February 17^th, 2017 from

http://www.taxpolicycenter.org/briefing-book/

  ^6,7,Summary of the Latest Federal Income Tax Data, 2016 Update. Tax Foundation. Retrieved

March 11, 2017 from https://taxfoundation.org/summary-latest-federal-income-tax-data-2016-update/

 ^8,10Fact Sheet: Taxing Wealthy Americans. Americans for TaxFairness. Retrieved March 11^th,

2017 from https://americansfortaxfairness.org/tax-fairness-briefing-booklet/fact-sheet-taxing-wealthy-americans/