Reforming the Income Tax: A Citizen's Proposal
Description of the Preliminary Model

Richard A. Demers
Minneapolis, MN
May 17, 2012

Introduction

The following ideas from Reforming the Income Tax: A Citizen's Proposal are modeled in a spreadsheet spreadsheet in order to provide a level of confidence that they are reasonable:

• That all income (personal, corporate and non-profit) should be taxed in a uniform way.
• That FICA and Medicare wage taxes should be eliminated and these programs financed through income taxes.
• That personal income should be taxed on an individual rather than a household basis.
• That no income should be excluded from taxation by deductions, credits, exclusions or other loopholes.
• That it should be possible to freely transfer income to other people and organizations who are then responsible for any taxes on it. These models, however, only consider equal distribution of income to the members of a household.
• That the amount to be collected in taxes should be determined by the amount to be spent, and not the other way around. The amount to be spent is a separate issue, subject to normal budgeting procedures. Note, however, these models assume the total income revenue of 2009 is an equivalent target.

The spreadsheet includes three versions of the Offset Log Tax described in the proposal. More complete models will have to wait for access to better data sources; in particular, data sources that include high income individuals and corporate and organization income data.

Data Sources

The models use real world data for 2009 from the US Census Bureau table HINC-01: Selected Characteristics of Households, by Total Money Income in 2009. In particular, for each of the income ranges identified in HINC-01, the data for "All Households" (the number of households in each range) and "Mean size of household" (the average number of persons in each household) was extracted. For incomes less than $200,000, this data was regrouped into ranges of $10,000. In addition, HINC-01 also provides a single range for "$200,000 and over".

The chart in the Distribution sheet of the spreadsheet illustrates the distribution of households across the ranges of income. It also shows how total income is distributed across the range.

Tax Revenue Data

This section of the model contains the total revenues obtained from individuals in 2009 through Income taxes, Gift taxes, Estate taxes, and FICA and Medicare wage taxes ($1.796 Trillion).

This section also contains the total income tax revenue for corporate and non-profit income tax revenue ($228.9 Billion) for 2008 (2009 data could not be found). At this time, no way has been found to distribute these sums over ranges reflecting the incomes of these entities. Therefore, they have been included as a lump sum when calculating k values.

The sum of these revenues ($2.024 Trillion) is the amount of revenue that the Offset Log Tax models must each generate.

Individual Income Range Data

This section of the model contains the raw data of the model adjusted for each range of household incomes.

• Income Ranges. Defines the income ranges considered by the model.
• Medium household income of range. This provides the models with a single income value in each income range for calculations.
• Taxable income. This is the sum of the medium income of the range plus the FICA and Medicare additions.
• Number of households in each range. Given the fact that some households have billion dollar incomes, this data spans nine orders of magnitude of income. The raw data is, therefore, summarized into ranges whose size also increase by powers of 10:
  • $0 to $100,000 by ranges of $10,000
  • $100,000 to $1 Million by ranges of $100,000
  • $1 Million to $10 Million by ranges of $1 Million
  • $10 Million to $100 Million by ranges of $10 Million
  • $100 Million to $1 Billion by ranges of $100 Million.

But how should the model distribute the 4,506,000 households with income greater than $200,000 across the 36 higher income ranges of the model when the data should be clearly skewed toward the lower end of range incomes? To accomplish this a reversed Fibonacci series was used heuristically, as shown in the RawData page of the spreadsheet. The result is not completely satisfactory, being artificial, but it provides values for what is hopefully a more realistic model.

• Mean size of households. Data from HINC-01. For income ranges less than $200,000, the weighted average of data from HINC-01 ranges is used. For ranges greater than $200,000, the single value from HINC-01 is repeated.
• Number of people in range. (Number of households × Mean size of households).
• Mean income per person. (Medium household income ÷ Mean size of households). This is an individual's income after equal distribution of household income through transfers to all its members. The proposal allows income to be transferred to the members of a household (and to other people and organizations) any way they want, but that level of modeling is not possible in a simple spreadsheet.
• Addition for employer part of FICA. (.062 × Mean income per person - for income < $106,800). Instead of employers paying FICA taxes, this amount must be returned by employers to each individual. In this proposal, FICA financing is via income taxes on all individual and corporate income.
• Addition for employer part of Medicare. (.0145 × Mean income per person - for income < $1,000,000 since those with greater income are generally self employed). Instead of employers paying Medicare taxes, this amount must be returned by employers to each individual. In this proposal, Medicare financing is via income taxes on all individual and corporate income.
• Taxable income per person. (Mean income per person + FICA addition + Medicare addition).
• Range income. (Number of people in range × Taxable income per person)

Models

The models described herein calculate the taxes that an individual would be assessed by three variations of the Offset Log Tax formula.

The Offset Log Tax model is defined by the formula:

Tax = (k × Log10(Income) × Income) + Offset

where k is a constant whose value is determined heuristically; that is, by varying the value of k until the Total Tax Revenue generated by the model equals the target Total income tax revenue.

The following variations are considered:

• 1. Log tax, no offset

  Offset = 0 and everyone is assessed a percentage of their income as taxes. The actual rate is affected by k and the base 10 logarithm of the income. Everyone is assessed this tax, regardless of their income. Due to the Log₁₀(Income) factor, the tax is more progressive than a flat rate tax, but it still adversely affects low income individuals less able to pay.

• 2. Offset = $minus;3650, tax floor = $0

  Offset = -$3650 (the same as the 2009 personal exemption) and everyone is assessed a percentage of their income as taxes after the offset is subtracted. In the sense that the offset applies to everyone, this is like an exemption. If a tax less than $0 is calculated, no tax is collected. The difference in revenue from model 1 must be made up by higher income ranges.

• 3. Offset = $minus;3650, negative tax

  Offset = -$3650 and everyone is assessed a percentage of their income as taxes after the offset is subtracted. If a tax less than $0 is calculated, the absolute value of the assessment is paid by the government to the individual being taxed - a negative tax. The difference in revenue from models 1 and 2 must be made up by higher income ranges.

Charts

The chart in the Distribution sheet of the spreadsheet shows the number of people at each income level and the total income of people at each income level. Note that a small number of people have a relatively large income.

The chart in the Rates sheet of the spreadsheet shows tax rate paid by persons at each income level for each of the three tax models. Note that the offset to the calculated tax has a large effect on the tax rate, but that the small difference in tax rates between the $0 tax floor model and the negative tax model. Depending on the size of the offset, he negative tax model could be an alternative to the Earned Income tax credit.

The chart in the Revenues sheet of the spreadsheet shows the percentage of the total tax revenue that is paid by people at each income level. The percentage peaks at middle income levels because most people have that level of income.

Family of Four Examples

This section of the model calculates family taxes according to the three models of the Offset Log Tax. Taxes are calculated separately for each family member and then summed for the family.

• Example 1 - no transfers to outside organizations, no distribution among family members. Taxes are calculated as if all household income came from one individual. This provides a strawman for comparison with the other examples.
• Example 2 - no transfers to outside organizations, equal distribution to all family members. This example matches the way in which the values of k are calculated in the Model sheet. This is probably the best scenario for low income families.
• Example 3 - 10% transfers to outside organizations, distribution skewed to the adult members of the household. Taxes are calculated separately for each family member. This is probably the best scenario for middle income families.
• Example 4 - 50% transfers to outside organizations and most income retained by a single individual. This is a possible high income scenario.

Corporate Example

This section of the model calculates taxes for a corporation according to model 1 of the Offset Log Tax. Dividends paid to stockholders are considered transfers of income from the corporation to them. If the corporation doubles or triples the dividends it pays to shareholders, substantial tax savings are accrued.