Planting a simpler and more fair tax tree

Every now and then, I challenge us to think about the way our tax system works. Originally published in 2010 as “We’re growing the wrong tax tree,” I invite you to consider that our tax system is upside-down – and how we might plant a simpler and more fair tax tree.

After a lot stress, we mailed our federal tax returns. I am always struck by how complicated our tax code is, both at the Federal and State levels. Our tax codes desperately need to be simplified.

According to the IRS, “The estimated average time burden for all taxpayers filing a Form 1040 or 1040-SR is 13 hours, with an average cost of $240 per return.” Looking a little more closely, “nonbusiness taxpayers are expected to have an average burden of about 9 hours and $160, while business taxpayers are expected to have an average burden of about 22 hours and $470.”

(I think this number understates the anxiety of understanding and preparing tax forms.)

Beyond its complexity, and the irony of paying money to calculate how much money we owe the government, the foundation of the tax code seems flawed to me.

Our current tax system is like an overgrown banyan tree, with roots extending down and spreading over the whole economy. Banyan trees are beautiful and complex and have a lot of historical and spiritual meaning, but it’s not what we need in a tax system.

The federal government, which is funded by every taxpayer in the United States, has the highest income tax rates – up to 37%.

The state government, which is funded by residents and part-time residents, has income tax rates of up to 11% in Hawai’i (only California has a higher tax bracket of 13.3% in 2021).

(To be fair, state governments have other sources of revenue, such as sales taxes (or general excise taxes in Hawai’i), property taxes, transient accommodations taxes, gasoline taxes, and permit/usage fees.

But state governments must also comply with and fund federal regulations and mandates, which may or may not be funded by the federal government.)

With its broad tax base, the federal government doesn’t spend all of that income tax revenue, so it ends up apportioning it back to state governments as mandatory spending, discretionary spending, and supplementary spending.

Or it ends up duplicating programs that already exist at the state level, programs that are designed and revised according to the needs of the individual states.

I think that we are growing the wrong tax tree.

Instead of a banyan tree, it makes more sense to have a tax system like a strong pine tree, with a slender trunk and a wide canopy.

With a tax system like a pine tree, the federal government (the tree trunk), which has national responsibilities and a larger tax base, would have lower income tax rates. The states (the crown of the tree), which directly care for citizens but have smaller tax bases, would have higher income tax rates and rely less on federal funding.

With a tax system like a pine tree, taxes would increase as we get closer to home, and closer to the local governments that know our needs best.

How much time would you estimate that you spend on tax preparation? How would you improve our tax system? What changes could we make to simplify the tax code in Hawai’i or and the federal level?

Starting over with the tax code

What if the Hawaii tax code disappeared overnight and we had to start all over? What if our government had to design tax returns that fit on one page, with one page of supporting information (if necessary)?

What if we could force the tax return people to sit down in a room with a computer, no Internet access, and a TV camera to broadcast all of their discussions?

If we had to start all over again, here are five ways to make the tax code simpler and easier to understand:

* State sales tax on retail sales, NOT a general excise tax (GET). The sales tax would tax all retail-level goods and services, perhaps at 7%. It would exclude food, drugs, and medical care. There would be no taxes at the manufacturing or wholesale level, which would save us all a lot of money because the prices of foods and goods would decrease. There would be no Internet or out-of-state sales, because we don’t have the power to impose a tax on another state.

* Flat state personal income tax, not a progressive tax. Personal income (salaries, wages, tips, commissions, bonuses, prize winnings, gambling earnings, royalties, and pass-through business income) would be taxed at a single flat rate, perhaps 5%. The standard deduction would be lower, so that more people would pay taxes at a lower tax base. We would eliminate most tax credits for individuals, except for education and child care expenses, health care expenses, retirement contributions, and charitable contributions. I know that many people would be angry about losing the homeowner’s tax credit, but maybe we need to shift our priorities to having a home, not necessarily owning a home.

* Flat state business income tax, not a progressive tax. Business income (sales, royalties, licenses) would be taxed at a single flat rate, perhaps 5%. We would eliminate most tax credits for businesses, except for a small business tax credit to encourage entrepreneurs. Tax credits to lure businesses to Hawaii would have to be on a graduated scale, with smaller tax credits in succeeding years or for additional projects.

* End state income tax withholding. In a way, our income taxes are “hidden” because they are withheld from our paychecks and we never even have the money in the first place. If we eliminate withholding, we’ll see how much we are really paying in income taxes when we fill out our tax returns. In addition, it would reduce the paperwork for businesses; after all, why should businesses collect taxes for the government?

* No taxes on investment income (interest, dividends, and capital gains), up to a set amount that is adjusted for inflation. Investment income over that amount would be taxed at a low rate, perhaps 3%. We want to encourage savings and investment, and discourage frivolous spending. We shouldn’t penalize savings; the more money we save, the more money the banks can lend in our communities.

We can’t control the federal government – not unless other states join Hawaii in calling for a complete overhaul of our tax system. But we can work to change Hawaii’s tax system.

We all deserve reasonable taxes that we can all understand, and we can make it happen. How else can we simplify our taxes? If you disagree, what are your suggestions?