As the US economy has slowly improved over the past two years, the tension and hype around federal budget deficits and debt limits has receded some.  Congress is easily distracted from the important to the urgent and nobody likes talking about spending cuts, program changes, tax increases, or deficits in any event.  These are all topics that create great theatre but also raise the ante in the political gambling arena called “an election year”.  For most incumbents, tackling these issues now is not in their best interest.

But the fact remains that our country’s economic business model is broken, both at the revenue line and in expenses.  Fixing our financial fundamentals should be a top priority, especially for those that represent us in Washington, DC, and yet another year will pass where essentially nothing gets done.  This failure in leadership and management needs to be exposed for what it is – negligence of the highest degree.

While there is certainly great need to rethink program spending and tackle difficult issues like health care, defense spending, and social security, today’s blog post will focus on the revenue side of the equation.  So let’s begin with the inconvenient but obvious truth:  through all of the rhetoric about “class warfare”, “trickle-down economics”, and corporate greed, it’s painfully obvious that we need to transform our tax system in fundamental ways that increase fairness, raise more revenue, and incents individuals and companies to invest.  Done well, we can improve the system AND raise more money.

Here are 5 tax policy items I’d address first…

1. Simplify our Tax Structure.

I am sure the vast majority of Americans believe they pay too much tax, but if you actually asked them what tax rate they pay (either average or marginal), most would have a difficult time coming up with the correct answer.  While I think of myself as a reasonably sophisticated business person, I fell into this same category and had to do a good bit of research to determine our tax level and understand why we paid that percentage of our earnings.

2. Simplification will Lead to Transparency 

It will expose areas where the tax code is “unfair” or otherwise biased in favor of or against certain interests.  We need a comprehensive set of tax reforms that dramatically reduces the number of deductions, exemptions, and special incentives that bias the tax code in difficult to understand directions.  The most obvious example is the need to eliminate private equity loopholes (especially carried interest provisions) so that the definition of “earned income” actually makes sense.

3. Restructure Corporate Taxes

On the corporate side, our tax code is equally opaque and is filled with a bewildering set of incentives, loopholes, and programs, each of which creates a set of “winners” and “losers” in the tax code lobbying war.  Regulating and incenting certain business activities through our tax code is both inefficient and assumes that the taxing authority has some type of crystal ball displaying which activities should be increased and which should be reduced.  Given that we rarely sunset tax incentives and provisions, the resulting tax code piles up on top of itself like rocks at the bottom of a glacier creating a logjam of complexity and inefficiency.  The company with the best lobbyists and tax attorneys wins.

In fact, nominal corporate tax rates are actually higher than in most countries and should be lowered.   This would help a large number of businesses (especially smaller businesses) who are less able to take advantage of special incentives and also encourage repatriation of foreign profits (and future income) from larger companies on which no tax is paid today.  At the same time, many tax incentives that bias corporate activity and lead to significantly lower actual rates should be removed creating an easier to understand tax landscape and replacing any revenue lost through lower nominal rates.

4. Leadership?

While the specifics of achieving this grand simplification are not nearly that simple, the basic paradigm is straightforward and a variety of groups have made proposals that would achieve much of what I’ve outlined above.  And it can be done in a revenue neutral or even positive fashion.  Certainly, there would be “winners” and “losers” based on their current position in the status quo – but our political leaders could address a major thorn in our economic business model if they tackled this challenge constructively.  The question is one of leadership…

All of which leaves us with one remaining elephant still sitting in the middle of the room.  Our tax system is designed to be “progressive” meaning that those who earn more pay a higher percentage of their earnings in taxes.  And many at the lowest end of the economic spectrum actually pay little or no tax.  Within reason, this makes good sense to me – those who can afford to pay more, should pay more.  But that still leaves us with the elephant:  how much more is reasonable?

At the highest end, marginal federal tax rates have increased from 36% to 42% (including the impact of the Affordable Care Act taxes) and capital gain and dividend rates have also increased by 5%.  And if you live in California, your taxes have increased significantly more than this.  With all of that said, there are those that believe these upper end rates should be even higher – and certainly many countries in the world have higher marginal tax rates for the wealthiest individuals.

5. Charity Tax

In my view, the correct way to think about this is “how do I want the next dollar of my money spent on the public good?”  For me, the short answer is I’d rather donate it to any number of charities than give it to the federal government.  In effect, I’ve reached a tipping point where I’m unwilling to give Washington, DC more of my money because I don’t think the money would be spent wisely.  I’d much rather take the next 5% “tax increase” and allocate it myself to the charities I know are directly, efficiently, and effectively dealing with real social issues.

Put another way, compare two outcomes:

1. You give the next 5% of your money to the Federal government
2. You give the next 5% of your money to 3 social charities of your choice.

Now ask yourself the question:  “Would we achieve better societal outcomes in scenario #1 or scenario #2?”

My money is on the charities every time – and I’d be a big fan of a voluntary charity tax. What do you think?