Today, we no longer question that income taxes are a part of life, just as inevitable as death or any other type of tax. But before World War I, the United States levied an income tax only sporadically. Most of the government’s revenue comes from excise taxes and customs duties.
So what would happen if we eliminated income taxes today? Will society descend into Mad Max-style anarchy?
not at all. Different governments use different types of taxes to fund themselves. Nine state governments already do this: they impose no income tax and fund themselves through property, sales and excise taxes.
Regress or progress?
Because our highly polarized society lives in political echo chambers and sees everything through its own tribal lens, the first question people want to know is: “Will eliminating the income tax be regressive?” (regressive meaning) To reduce taxes on the rich).
No, not necessarily. It depends on what you replace it with.
This actually makes this thought experiment politically agnostic. You can take a regressive or progressive direction.
For example, suppose you eliminate the income tax and replace it with excise taxes on tobacco, alcohol, marijuana, and gasoline. This would be regressive because it would impose a relatively high tax burden on low-income Americans.
Now imagine the opposite extreme: you replace income taxes with steep tax brackets for property and sales taxes. For example, the government imposes no property tax on homes worth less than $200,000, but imposes a 1% property tax on every $200,000 worth over $200,000. Therefore, a home worth $350,000 would pay 1% property tax ($3,500), a home worth $550,000 would pay 2% ($11,000), and a home worth $750,000 would pay 3% ($22,500). ,So on and so forth.
You can do the same thing with sales tax. Maybe the government doesn’t impose sales tax on groceries, but has tiered tax brackets on clothing, cars, boats, luxury goods, etc. If you wanted to bend tax rules in a green direction, you could impose a higher sales tax on vehicles with lower gas mileage.
What’s the bottom line? You can establish these tax brackets as you wish, making them as fixed or progressive as you prefer. The concept itself does not lean in any political direction.
Advantages of abolishing income tax
First, eliminating the income tax would make the tax code simpler. We don’t need thousands of pages of rules, exceptions, exemptions and loopholes.
Don’t you like that the wealthy pay a relatively low percentage of their income in taxes compared to professionals? This happens precisely because tax laws are so complex. The wealthy can afford to hire savvy and expensive tax lawyers to find every loophole in the system and exploit them.
Property and sales taxes are clear and transparent. If you own a $10 million mansion, you can’t escape property taxes. You pay a percentage of the appraised value, hard stop.
In fact, the main reason we need the IRS is the complexity of enforcing income and corporate taxes. Throw them away and you jettison (mostly) the IRS and the $16.1 billion spent last year to run it. You don’t see the city trying to enforce property taxes: if someone doesn’t pay, they put a lien on the property and auction it off.
Finally, income taxes create accounting and tax preparation nightmares for millions of Americans. The average American spends 13 hours a year preparing their tax return, with many spending hundreds of hours.
Imagine all the time and stress that would be saved if no one had to file a tax return and we just had to pay taxes every time we swiped our credit card or paid our property tax bill!
Disadvantages and Risks
By this point, you’ve probably raised a dozen objections. Here are some factors to consider.
First, a federal sales tax would incentivize private sales and black market transactions. If the sales tax jumped to 15% overnight, suddenly everyone would be interested in paying cash.
Likewise, bartering will become increasingly popular. If two people find that they both have something the other wants, maybe they can reach a settlement that doesn’t involve money changing hands.
This forces us to rethink our assumption that we don’t need the IRS as an enforcement agency simply because the tax code is simple and transparent. Sales tax, of course, is both, but if everyone suddenly started evading tax by buying items under the table, we’d still need agents to force people back in line.
What about wealthy people who pay huge sales taxes when they buy luxury goods like yachts? Maybe they just hop on a plane and go to another country to buy that yacht.
In other words, maybe sales taxes are easy to enforce because they are relatively low.
Impact on real estate and investors
Finally, higher property taxes create another set of problems for real estate investors.
We run a passive real estate investing club where we get together every month and review different types of properties for us to invest in as a group. Different property types have different risks, and sudden federal property taxes will certainly be affected differently.
At first glance, you might think that a hefty property tax increase would put downward pressure on home prices. After all, it increases the total cost of ownership.
But I would refute this assumption. Remember, the owner will no longer have to pay income taxes. They still need a place to live, so they’ll pay prevailing housing rates and save on income taxes to pay property taxes.
This logic works well enough for residential and industrial real estate, but it becomes more shaky when you apply it to potentially non-significant property costs like office space. Imagine a company retaining offices because they like the idea of the team getting together at least a few days a week. But if their office rents rise due to higher property taxes, then their thinking may shift to “what the hell; what the hell.” Let’s go completely remote.
Then again, you might say that’s not a bad thing. Perhaps these buildings can better provide housing supply for our cities, thereby reducing commuting and greenhouse gas emissions. These are controversial points.
Governments rarely give up revenue sources
There are no longer major political parties fighting for fiscal conservatism. The Trump administration’s spending far exceeds that of the Obama administration. This means that the government will continue to spend huge amounts of money uncontrollably, and the federal government will never abandon the income tax now that it has trained us to accept it.
The tax benefits are one of the many reasons I love real estate investing. In particular, I use a lazy 1031 exchange strategy to minimize my income tax expense. It works because I can invest a small amount of money into new syndicates every month through SparkRental’s Syndicate Investment Club. All of this should get you thinking about your tax strategy: The more income you keep in your pocket and away from Uncle Sam, the faster you can secure your financial future.
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Notes on BiggerPockets: These are the opinions written by the author and do not necessarily represent the views of BiggerPockets.
