For savers, wealth erosion comes in two main forms: Inflation and taxes. Inflation, or a rise in prices that erodes your buying power, can slowly eat away at your "real" earnings, meaning that even cash can result in losses if the inflation rate outpaces your yield. The other form of wealth erosion, taxes, is much easier to see. After all, you pay taxes regularly, including paying taxes on the interest earned from your savings account.
Some believe that our tax code has become too complex, and that it is unfair to a large percentage of the population. After tax deductions and credits, and other breaks, there are quite a few Americans who actually don't pay taxes at all. Additionally, there are some who think the complexity of the system allows for wealthier Americans to pay less than their "share." As a result of these concerns, the idea of a flat tax is gaining traction. Indeed, two plans have already been presented by presidential candidates to overhaul the current system and replace it with some form of a flat tax:
- Herman Cain's 9-9-9 Plan: By now, most of us are familiar with this plan. The idea is that there is a flat tax of 9% for income, 9% for businesses, and a 9% federal sales tax (added on top of state sales taxes). Recently, Cain added some provisions meant to ease the income tax burden on the poorest, since had received a great deal of negative blowback for the plan, which some estimates say would raise taxes on 84% of tax payers.
- Rick Perry's 20% Flat Tax: Most likely learning from the backlash against Herman Cain, Rick Perry introduced his own flat tax. Perry's flat tax comes with simple deductions, especially for those making less than $500,000. The most interesting aspect of Perry's plan, though, is that it's optional. You can choose whether to pay the flat tax, or pay according to the current system. (Perry hasn't been clear on whether this state of affairs would be permanent, or just a bridge to switching everyone over to the 20% flat tax).
In either case, though, there are major changes that would take effect. With Cain's plan, you are almost guaranteed to pay more in taxes, since the federal sales tax would raise costs significantly. With Perry's plan, you wouldn't have to pay more (at least as long as you have the option of keeping with the current system), but revenue would be severely limited. As a result of massive cuts, you might see changes to the programs you might be used to, since the funding would no longer be there.
Other Ways to Collect Taxes
A flat tax, in some form, is attractive to many because it provides a certain element of "fairness." There are few loopholes and deductions to take advantage of, and everyone pays the same percentage of their income (after any deductions, of course). In many flat tax scenarios, taxes on investment, interest and dividend income are done away with. There are flat tax scenarios, though, that allow for taxes on interest and capital gains.
Another option that is attractive to some is the idea of a tax on consumption only. Instead of taxing income, taxes are only paid when items are bought. This would likely result in some sort of Value Added Tax (VAT) system, as well as a national sales tax scenario. The prices of goods would go up, since there would be a tax collected on them. However, income wouldn't be directly taxed. Different scenarios for a consumption tax include those that:
- Only apply to new items. So what you buy second-hand, and had already been taxed once on the initial purchase, wouldn't be taxed again, so you wouldn't pay sales tax on used items.
- Exempt grocery purchases. That way, consumers aren't paying high prices on grocery items. You would still be taxed for eating out at restaurants, but food items at the grocery store wouldn't be be subject to the consumption tax.
- Additional luxury tax levied on top of the regular consumption tax for certain luxury goods and other luxury purchases
- Additional tax for "unearned" income: Some scenarios involved with a consumption tax actually allow for taxing interest income, dividend income and capital gains. This "unearned" income would be subject to taxes, but people wouldn't pay taxes on income derived as a result of their productive labor.
The idea of being taxed only on what you purchase, rather than paying income taxes on your productivity, is an intriguing one for many. Proponents believe it would encourage thriftiness, and encourage savers to keep saving. After all, right now, you are taxed on what you make, and there isn't much incentive to keep you from saving. (Quite the opposite. In the current low-rate environment, the incentive is to borrow, since yields on cash are low, and you can borrow for much less.) However, if you could pay lower taxes by saving your money, rather than spending it, more people might be inclined to cut their expenses.
This would change a great deal about our economy, having the possible effect of shifting it away from one driven by debt-fueled consumer spending. A fundamental change in the way we think of what makes a "good" economy would have to be experienced as well, since we would no longer be looking to encourage economic expansion by inflation. It's probable that there would be a great deal of financial pain and difficulty for many before emerging on the other side.
What do you think? Do you think our tax plan needs to be overhauled? What type of plan would you like to see? Do you think that our economy would benefit from moving away from being growth obsessed to favoring savers a little more?