Taxes for dummies...

Friends, I'm sure that you've noticed that another great American tax day has come and gone!

I read some of the "think tank" thinking and I have to confess that it gave me a headache. There was too much talking about "framing", "revealing truths", and "intertwining" - maybe you'll get more out of it, but...

Here's some really simplistic thinking to put into your think tank.

First and foremost taxes should go to support the common good. Secondly, the basic needs of citizens should not be taxed.

Given these two principles, one might propose a magically simple system where the first $50,000 of income from any source would be exempt from income taxes. Any and all income above $50,000 would be taxed at a flat rate (let's say 10%). And all income from any source would be subject to Social Security and Medicare taxes. And finally, each individual earning income files an individual tax return - no joint returns.

The entire IRS instructions for individuals have been reduced to one paragraph.

Let's work through a few examples:

Example 1. Joe earned $23,000 in 2006:

• Federal income tax: $23,000 - $50,000 exemption = $-27,000, therefore any tax withheld from Joe's paychecks would be returned as a refund to him.
• Assuming Joe was paid weekly, the income taxes withheld from his check would be $23 a week - totaling a $1,196..00 refund for the year.
• Social security - employee contribution (0.062) - $1,426.00
• Medicare - employee contribution (0.0145) - $333.50

Joe pays a total of $1,759.50 in federal taxes, leaving him at an effective tax rate of 7.65% all going to Social Security (SS) and medicare. He ends up with $21,240.50 in expendable income.

Example 2. Mary earned $53,000 in income in 2006:

• Federal income tax: $53,000 - $50,000 exemption = $3,000 in taxable income. She owes $300 in income tax, any amount above that withheld from Mary's paychecks would be refunded to her.
• Assuming Mary was paid weekly, the income taxes withheld from her check would be $105 - totaling $5460 for the year. Mary would receive a $5,160.00 refund.
• Social security - employee contribution - $3,286.00.
• Medicare - employee contribution - $768.50.

Mary pays a total of $4,354.50 in federal taxes - leaving her at an effective tax rate of 8.22% with some in the general fund but most of it in SS and Medicare. She ends up with $48,645.50 in expendable income.

Example 3. Paul Wolfowitz's banking friend earned $193,000 in income in 2006:

• Federal income tax: $193,000 - $50,000 = $143,000 in taxable income. She owes $14,300 in income tax. Assuming she is paid weekly, the income taxes withheld from her check are $797.83 totaling $41,487.16 for the year. She would receive a refund check for $27,187.16.
• Social security - employee contribution - $11,966.00.
• Medicare - employee contribution - $2,798.50.

Chickie pays a total $29,064.50 in federal taxes with the majority going to the general fund. This leaves her at an effective tax rate 15.06% and an expendable income of $163,935.50.

Example 4. Rex Tillerson, CEO of Exxon Mobil, earned $38,000,000 in 2006:

• Federal income tax: $38,000,000 - $50,000 = $37,950,000 in taxable income. He owes $3,795,000 in income tax.
• Assuming that he has a cash flow problem and needs a weekly check, the income taxes withheld from Rex's check would be $255,207.74 - totaling $13,270,803 for the year. Mr. Tillerson would receive a refund of $9,475,802.50.
• Social security - employee contribution - $2,356,000.
• Medicare - employee contribution - $551,000.

Mr. Tillerson pays a total of $6,702,000 in federal taxes leaving him at an effective tax rate of 17.64% and an expendable income of $31,298,000.

If you've been paying attention - you've noticed that the "flat tax" rate has actually "progressed" as individuals earned more money.

Would the majority of American citizen's benefit from such a "simplified" tax system?

I could have simplified it further on the withholding and refund side but I became concerned for all the tax preparers, financial advisers, accountants and tax lawyers whose lives have just passed before their eyes.