Friday, June 21, 2013

The Object Tax in a Nutshell

The Object Tax is named after a software design technique used in complex system design. It is used in products such as the smartphone. The smartphone is in incredibly complex device with an easy to use interface.

The Object Tax has the goal of transitioning from an income tax to a consumption tax with minimal disruption. The design is likely to create an intuitive interface for the tax system.

Object Design starts by making an abstract tax code that can implemented as an income tax or as a product offered by a third party.

The first step is to separate the tax from the implementation. The designers would create a model of the tax code stripped of the detail used in tax collection.

The abstract model might start by saying: "Financial objects will be taxed at a progressive tax rate at some point between income and consumption."

The abstract model can include things like standard deduction, exemptions, itemized deductions and other prominent features of the current tax code.

The abstract model can be implemented as an income tax or developed into a product delivered by a third party financial firm. The model will include rigorous test scenarios to assure that different implementations of the model come up with the same result.

With the abstract model defined, we would invite private financial institutions to step in and design products that implement the code.

The third party products would be put through rigorous testing and certification to assure the taxes collected are comparable to the income tax.

Financial institutions would line up to develop products because they are all competing for customers. The financial institutions that implement the code will compete on creating secure intuitive interfaces for collecting the tax.

The process is similar to the development of the smartphone. Providers compete to develop robust but intuitive designs for their products and services.

The Object Tax separates the tax from the implementation of the tax. The design creates one tax code with many possible implementations. Each person will choose their method of implementation.

The tax is designed so that it can be implemented as an income tax. We invite financial institutions to create other implementations of the tax. Taxpayers will not switch to the new taxing method until financial institutions come up with innovative designs that compel people to switch. The design is not disruptive.

The Object Tax creates an abstract tax code with many possible implementations. Accountants will develop implementations in which the tax is collected as part of the standard bookkeeping process. Others will create implementations of the code for people who want to live off grid and do their finances in cash.

There can be implementations for people who want to do all their financial transactions in silver coins and for people who engage in bartering.

The Tax Aware Account is simply one possible implementation. (BTW: The tax aware account design does not assume the account is held by a bank. The money in the tax aware account could be paper securities. It could be in gold coins held in a safe at the bottom of a pit under a doomsday bunker guarded by hungry pitbulls.

The Object Tax is one tax code with many possible implementations. Third parties create implementations. Third parties will create innovative products to process the tax.
One possible implementation of The Object Tax is a Tax Aware Account. A Tax Aware Account works as follows: An employer will deposit a workers' entire paycheck into the Tax Aware Account. (This eliminates the tax withholding and need to file a W2 Form). When the employee withdraws money, the Tax Aware Account will execute the tax code.

So, lets say you put $1000 into your tax aware account and that your progressive tax rate is  20%. When you withdraw the money; The Tax Aware Account will give you $800.and pay $200 in taxes.

The Tax Aware Account can implement a complex tax code with exemptions, deductions, tax credits and whatever Congress throws at it.

Since the account is processing the tax code in real time, it should be possible to eliminate the need to file an annual tax return.

A Tax Aware Account is a true consumption tax. Employees get their entire paycheck. The account is invested in securities of the workers' choice. The tax is collected directly from the worker at the moment the worker transfers money from the account for spending.

Collecting taxes at the moment the taxpayer prepares to spend money helps protect the taxpayer's privacy. The government does not see how the money is spent.

In contrast, a sales tax is not a true consumption tax. A sales tax is collected by a business. The money collected flows directly from the business to the government.

The goal of a consumption tax is to encourage savings. The goal of the consumption tax is best achieved when the money flows directly from a taxpayers savings at the moment the taxpayer chooses to spend.

The money collected in a sales tax flows from the retailer to the government. Because the flow of money is indirect, the sales tax does not create a direct incentive to save.

To understand an economic system, follow the money.

The effect of a tax is determined by the flow of the money and not the point of collection. The money in a sales tax flows from the business to the government. Such taxes suppress business. They have only an indirect effect on savings. The effect is often opposite of what we desire (more savings).

In a true consumption tax, the money should flow from the consumer to the government. The Tax Aware Account created by the Object Tax is a true consumption tax. Money flows from the consumer's savings. This directly encourages savings.

We can use the creation of the Object Tax to handle other complex challenges such as the Capital Gains and Inheritance Tax.

I would eliminate capital gains as follows. I would say that investors can buy and sell stock from a Tax Aware Account without any tax considerations. Investors would be taxed at a progressive rate when they transfer money from their Tax Aware Account for spending.

Money earned by investment would be taxed at the same rate as money earned by working.

I would like to tweak the progressive tax rate a bit. Currently the progressive tax rate is based on yearly income. I would like the progressive rate to be aware of the total size of an investment. Warren Buffet should pay taxes at the highest progressive rate even if his declared income is small.

The Object Tax handles inheritances as follows. It says that the heirs will inherit the tax status of  the assets. If the parents have a Tax Aware Account, the heirs will inherit that account in full. They would pay taxes at a progressive rate when they withdraw the money for spending.

If the family farm was held by a Tax Aware Account, the heirs could inherit and continue to work the farm without disruption. The heirs would be forced to pay taxes at a progressive rate if they chose to sell the farm.

I named the Object Tax after design techniques used in Silicon Valley to create complex software projects. The goal of the design is to create a new generation of software products that collect taxes at an individual level.

This approach creates a mechanism to switch from an income based tax to a consumption tax with minimal disruption. This approach will also end up creating a new generation of software products that help individuals master their finances.

No comments: