Proposal for Restructuring
of the U.S. Federal Income Tax System

Edward J. Dodson

[Submitted for consideration to the President's Commssion on Tax Reform, April 2005]


The objectives of reform of how our Federal government raises revenue ought to combine simplification of compliance with progressivity, without being excessively confiscatory. The history of tax law and regulation in our country is a history described by political scientists as one of "disjointed incrementalism." Principle has taken a back seat to expediency and the politics of bending to special interests to the detriment of the common interest. My proposal is the replace the existing Federal income tax structure with a "graduated flat tax" system." The details are as follows:

  • Tax Base. Individual incomes independent of the source would be reported.
  • Exemptions, Deductions and Exclusions. Individual incomes up to some maximum (the national median is suggested) would be exempted from taxation. No other deductions, exemptions or exclusions would apply.
  • Tax Rates. Individual incomes above the above exclusion would be taxed at increasing rates of taxation, up to a maximum rate established periodically based on the requirement to achieve a balanced budget. For purposes of example, assume the national median income is $50,000. The graduated flat tax structure would impose a rate of, say, 5% on incomes greater than $50,000 up to $100,000; 10% on incomes greater than $100,000 up to $250,000; 15% on incomes greater than $250,000 up to $500,000; 20% on incomes greater than $500,000 up to $1 million; and, 25% on incomes greater than $1 million. Note, the exact rates and income ranges can be adjusted as needed.
  • Distribution of Tax Burden. The above structure effective exempts virtually all low-income individuals from taxation. Moreover, the effective rate of taxation is lowest on activities most directly associated with the production of goods and services. Incomes received by passive investment will (by virtue of the actual distribution of such sources of incomes) experience higher rates of taxation.
  • Treatment of Charitable Giving. This proposal provides for no special consideration of charitable giving. A provision to permit deductions from gross income for such contributions adds complexity (and the tracking of whether the recipients are legitimate charitable organizations imposes duties on the Internal Revenue Service which have proven difficult to perform to this point).
  • Treatment of Home Ownership. This proposal provides no provision for deduction of mortgage interest or local real estate taxes.
  • Collection Method. The graduated flat tax structure as proposed results in enormously simplified forms required for compliance. All income recipients would continue to file an annual report of income, and employers would continue to provide comprehensive reporting on incomes received by employees.
  • Treatment of Businesses. This proposal also recommends ending the imposition of the current tax on gross profits, to be replaced by a flat rate of taxation on gross revenue received by businesses. This change would accomplish two things: first, simplify compliance (reducing the need for the current army of tax accountants and tax attorneys employed by almost every business); and, second, reward success rather than inefficiency, as businesses with the same gross revenue will be taxed identically regardless of expenses incurred.

Impact of Proposal Relative to Current System

This proposal has obvious advantages in terms of simplicity. The potential to greatly reduce the tax collection bureaucracy are real. There is also real potential to shift resources to the extremely important societal issues of better regulating the nation's corporate sector. The fairness of this new structure is also readily apparent. Individuals who receive all or virtually all of their incomes from wages or salaries will be exempted or very lightly taxed. At the top end, the maximum rate will confiscate very little of incomes earned by producing goods or services and is (as measured by recent history) comparatively moderate.

The longer-term potential reduction in the "tax collection" industry and bureaucracy will contribute to the nation's economic growth and competitiveness. Modest rates and reduced complexity will result in greater compliance and huge savings in the costs of compliance for individuals and businesses, as well as administration costs incurred by government.

Transition, Tradeoffs and Special Issues

Two very important and intimately related issues are: (1) the need for legislation requiring government to raise sufficient revenue by taxation and other fees (e.g., the leasing of public lands to private interests under conditions of competitive bidding to achieve market rates of return); and (2) the gradual reduction in the nation's debt by conversion of existing debt as it matures with fully amortizing bonds that return to investors both interest and principle. The debt service payments required to achieve this result would need to be included in the budgeting process.