What would be a Fair Tax Code? To determine this one first must determine what is meant by the term 'fair'. If one desires to be objective, the definition of the word "fair" is one that is "just, unbiased, and honest". Let us attempt to chase the objective holy grail of fairness and build upon this objective definition of fair.
What would make an honest tax code? For starters, it should be simple and straightforward so that most everyone understands and can comply with it.
What would make an unbiased tax system? One that is relatively free from social engineering that favors one particular group over another.
What makes a just tax code? One that is equitable -- what applies to one, should apply to all.
What kind of tax code can we define using this objective foundation? To answer that one needs to determine what are some common needs for individuals in contemporary society. For starters, every self supporting individual has the need for basic living expenses of food and lodging. Beyond that, there is a need to promote individuals to save for retirement and other future expenses, and perhaps promote pooling resources for the catastrophic risks of life related to health care and disability. Each one of these topics deserves some comments and expansion. As a disclaimer, some of what I may discuss herein may be from the position of a devil's advocate and may on the surface seem at conflict with other perspectives presented in the Homestead. Such is the nature of the world of ideas, which allows one to view reality from various perspectives.
A fair tax code should provide a basic exemption from taxes or a lower tax rate on the basic needs of life -- housing, food, pension, and health care. The reality is that these people will still pay taxes as part taxes paid by many of those who provide these services. How any individual uses their basic living expenses should be generally reserved to individuals as is defined in the 10th Amendment with the caveat that those who show no ability to take care of themselves may have that responsibility delegated to outside agencies. If one desires to live with three roommates and save on housing expenses so that one can direct their resources elsewhere (such as saving for purchase of a house, college education, or eating out more often), one should be allowed that freedom as long as they don't become a burden upon society.
Some notable exceptions to this freedom 'might' be related to health care and saving for the future. Should an able bodied individual be able to skip out on health care coverage and thereby put the rest of society liable for coverage of any health care problem an uncovered individual might have? Should the same be true of allowing people to skip out on saving for a future pension. I think not, as it seems unjust for other individuals in society to be forced to pay for another's continued irresponsibility. However, this doesn't mean that I support a nationalized system of health care coverage or government run Social Security. There are many market solutions that result in a superior system of Health Care and Pension financing for all if properly designed.
One can debate the merits of whether or not it is desirable or fair to provide an additional exemption for dependents. It would seem reasonable as well as politically pragmatic to minimally provide exemptions for the first two dependents (as well as all existing dependents). To extend such exemptions to an unlimited number of dependents would seem to bias the tax code in favor of large families over those without families.
Society needs to recognize the need for a voluntary check and balance in population growth if humanity is to keep from overwhelming the world in the near future. Setting the dependent exemption at two or three should fulfill this requirement. Some exceptions might be made for multiple births, those willing to accept caring for elderly parents or adoption. Is such micro engineering wise? Or is it better to have society provide programs in place of promoting individual compassion? Such questions will have to answered by the political process.
One can also debate the merits of providing a subsidy (such as the Earned Income Tax Credit) for those of limited income so they can pay their full health care and pension savings without having to bear the full burden of that cost themselves. It would seem that in a fair tax code such a system needs to be balanced with the higher tax rates required of others to support such as system, what sort of entrapment is created between different tax rates as well as what types of charity systems are available to provide assistance to those of limited resources so that they can provide these benefits themselves. Such decisions are best left to politics although one is allowed their own opinion.
It is a fact of life that there is a need to save for a variety of future needs. Retirement living & 'Medicare', house purchase, education, and unemployment expenses are perhaps the primary needs for savings. There may be others options worthy of consideration such as disability and long term care insurance. It would seem fair to develop a tax code promoting savings with a similar structure to the day to day basic living exemption, only adapted to the peculiarities of savings and investment. In other words, all income from investments (or premiums) devoted to these causes up to a basic level should be free from taxation. Why exclude this income from taxation? Society functions best if individuals are promoted to be self reliant yet work together as a community. To achieve this goal, it is desirable to promote individuals to have some personal savings for hard times and future expenses. This can be best achieved if income from saving's is free from additional taxation.
Before proceeding it is necessary to look at the fine print in such a proposal that some might find surprising. Under a fair tax code, individuals subject to income tax, should pay the tax on the income that goes into savings beyond the savings initial threshold. However, no tax should be paid on additional income earned from such investments until one reaches a threshold where one has a life time worth of such investments/savings. If one determines it desirable for individuals to have some tax free deposits to savings, that issue should be directed to the Basic Exemptions. There are some very good reasons for this distinction.
Currently, our tax code for savings is set up in a popular, but typically backwards, biased and unjust fashion. The income put in an IRA or pension is not taxed upon deposit, but the IRA is taxed upon withdrawal. This back loaded pension tax system creates elderly special interests, who can and do use their block voting power to create additional special interest favoritism in the tax code for retired generations at the expense of younger generations, some of whom can't vote and some who are indeed not even born. The bias manifests itself in growing generational equity problems that few like to talk about. A fair tax code should address this issue directly and honestly.
Before leaving the topic of savings, it would be prudent to have some sort of upper threshold for savings, investments and annuities beyond which investment income would be taxed unless that invest income is related to the public good (tax exempt muni bonds, etc). That upper threshold for tax free investment income would be determined by the amount of projected expenses necessary to maintain a reasonable retirement (including health care) through the rest of one's projected lifespan. Basically, one ends up with the same fair tax system one has for regular wage income -- below a basic level one is not taxed, above that point one is subject to a single tax rate. In would seem prudent to dedicate any such taxes owed on investment income to retirement benefits for those of limited means. This would help create a stable self funding social net that could largely be free from the need for persistent political tinkering.
Generational equity is another perspective that needs to be looked at in a fair tax code. Basically, under the principle of generational equity, each generation should basically pay its own way through life. The bottom line is that upon passing, each generation should be subject to a broad estate tax that balances the books for that generation. This should be covered under a fair tax code by one of two ways (but not both).
First, one might determine that any wealth that is transferred to a non-spouse via an estate could be considered as income to the recipient and subject to the basic tax rules of that individual's income status. This would seem to be straight forward enough, but it doesn't necessarily create a system that would have each generation paying its own debts.
An alternate, and perhaps fairer estate tax code would be one that has low basic estate deductible (say 10k) so that most everyone would be part of the estate tax liability. There would be a low estate tax rate on the remaining wealth in the estate. The rate of the estate tax would be set according to the necessary funds required to achieve generational equity for that generations accrued social costs. Crude estimates put such a rate at around 12% or less depending upon that generation's self sufficiency. In otherwords, if a generation has a high degree of self sufficiency, it would be able to pass on more to posterity. Conversely, if there is a large social debt because of large social safety net payments for senior welfare, that generation would have a subsequently higher estate tax rate. This creates a check and balance that promotes the political will to support individual self sufficiency within a generation without compromising the need for a social safety net for those in each generation who might need assistance. However either system described herein would seem a fair foundation for development of generational equity.
As one steps through the process of developing a fair tax code utilizing the objective premise and foundation, one starts to develop a pattern of fairness that transcends the various aspects of our unique individual economics and life. It is possible to utilize some of this in developing a fair business tax codes. One also moves towards a tax code that is similar to the 'flat tax' proposals with some notable and debatable exceptions. It should also be pointed out that the resulting tax code would not be flat, but would instead be slightly progressive.
Perhaps what is needed is for the "Flat tax" code to be renamed the 'Fair Tax Code'. Over the entire spectrum of incomes and individuals, a fair tax code would strive to achieve a self sustaining counterpoise between basic individual needs and those who have enough success to embellish beyond those basic needs. It does so without leaving behind those struggling to make ends meet and without creating an impediment to further creation of wealth. It is the creation of wealth across the general society that assures the prosperity of the widest range of individuals within that society.
As a final comment, one should not overlook other numerous advantages a fair tax would have in promoting prosperity by allowing individuals to pave their own road to the American Dream as compared to getting lost in the maze of micromanagement created by our flatlander politicians.