When TurboTax spit out the estimated amount of our federal and California income tax refund would be this year, I nearly soiled myself.
I was flabbergasted.
My wife and I checked and rechecked the numbers, because the amount was the largest single tax refund I had ever seen.
As we combed through the numbers, it soon became clear what was afoot. For my family, the major difference between 2011 and 2010 was that, for various reasons, we earned about 35% in 2011 what we had earned in 2010. While our income in 2010 was nearly 3x our income in 2011, we paid about 16x as much in federal income taxes. Our federal refund alone is nearly 65x our 2010 federal refund.
These year-to-year extremes are far from atypical. In fact, even wealthy individuals earning similar incomes can have widely disparate tax bills.
For instance, investment manager James Ross paid 102% of his taxable income in federal, state and local taxes in 2010. that said, taxable income is “what’s left after itemized deductions like mortgage interest, charitable contributions, and state and local taxes are subtracted.” Ross’ total tax as a percentage of his adjusted gross income was 20%. However, since Ross’ deductions are based on expenses he already incurred, he had to draw on his savings just to pay his taxes.
More importantly, many individuals in Mr. Ross’ tax bracket pay far less than he does. The only difference is that they are able to take advantage of loopholes in that tax code either because of their chosen profession, tax jurisdiction, or the services of highly paid lawyers and accountants.
The bottom line is that the tax code is not meant to be unfair, it is just unnecessarily complex. The solution is not even more punitively progressive taxes – as my personal example clearly shows, they are already far too skewed – but a simpler tax code. If most Americans paid 10-20% of their income regardless of source, the government would likely earn more overall revenue. Of course, for reasons of long-term economic stability, some deductions would have to remain in some form like the mortgage deduction. However, the government should do everything in its power to streamline and/or minimize them.
Will the government ever endorse a modified flat tax of this nature? Probably not, but it is certainly worth a shot.