Last week I left you with an image of Cora trying to flatten herself. This week, I want to create an image of flattened taxes. Part of this tax-flattening process favorably regards our investment income.

About seven years ago, Texas Republican Dick Armey proposed a bill for a flat tax, and this bill is the one we'll concern ourselves with today. This is the same flat tax reform supported by former presidential candidate Steve Forbes. Frankly, if a simplified tax system saved 300,000 trees a year (which is about the number Uncle Sam cuts per year for his paperwork), I would be willing to see how this flat tax works, and how it would affect us personally and as a nation.

Armey's flat tax bill suggests that a tax doesn't begin until a personal allowance is exceeded. The personal allowance is $21,400 for a joint return, $14,000 for head of household, and $10,700 for individuals. There's also an additional standard deduction of $5,000 for each dependent.

Once these standard deductions are taken, the person filing the tax sends about 17% of the remainder to Uncle Sam. The whole tax form is about the size of an index card, and takes about two minutes to fill out. There are no lines for other deductions or income, including that of investment or unearned income, which includes interest, dividends, stocks, capital gains, etc.

Let's take the lady we've talked about in the last couple articles. Before she landed her promotion, she was making $35,000 per year, was head of household, single, with two children. Before she got her raise, she paid $1,444 in taxes after calculating her deductions and credits.

With the flat tax system, this woman would pay $1,419.15 in taxes. Not much difference, other than it would take her only five minutes to fill out and mail the form in to the IRS.

When this woman received a raise to $70,000 per year, her taxes jumped to $7,722. With the flat tax system, her payment would be $7,369.50. There's a larger savings than there was with her lower wages, but she's still paying in the same range as before. Plus, she's spending more hours away from the troublesome IRS paperwork.

The advocates of this program feel flat taxes simplify the tax process, would save Americans about 5.4 billion hours in tax preparation (and we know what billions mean), and give people more confidence in their economy?in other words, we would spend more.

The downside is the usual huff about revamping the system (it's a huge system to revamp), and the possible increase in population, because flat tax favors large families. If our woman decided to marry a man that didn't work and have another child, she would see a tax cut of about $1300 per year. If she stayed single and had another child, she would save $2,300 per year. I'm not sure that's enough reason to go out and create more children. I know children who eat more than $2,300 in food per year.

The point that caught my interest was the lack of taxation on investment gains. This, according to advocates for the flat tax, means that Americans would be more willing to support business through their investments. No Social Security tax would be paid, either. Frankly, I'm all for that. For some reason, I feel my SS payments are like throwing money to the wind. I've often wondered why I can't just take that money and invest it in my IRA.

The "Death Tax" would be obliterated. Income is taxed one time only, and that's the tax you pay on the money you earn while working. So what about the gal next door who rakes in $70,000 per year in inherited investment income while you slave away making the same amount of money that's being taxed by the government?

Right now this woman is paying 10% on her income while you're paying taxes in the 27% tax bracket. With the flat tax rate, your taxes will drop into the 17% tax bracket, and she won't have to pay a dime. However, the businesses that pay her investment income have already been charged the 17% tax, so she's actually paid her dues by accepting the investment income. She just won't have to fill out that postcard and mail it in to the IRS like you will. Life is like that sometimes.

The opposing forces to this bill seem to come from people who make a substantial income from tax preparation and charitable organizations. I'll ignore the former. The latter I worry about. Although advocates to the flat tax system say that people donate more when they have more money, I tend to believe it's because it puts them in a lower tax bracket. That's how it works with the current system. I would be concerned about keeping our charities alive, but I'm also concerned about keeping those 300,000 trees per year alive, too.

Since January 1, 2001, Russians have been paying a flat tax of 13% per year. Advocates and dissenters of the flat tax system in the U.S. and Canada have studied the results of this flat tax closely. These are some of the results:

• The 13% rate has exceeded expectations in terms of revenue, as the real ruble revenue increased 28%.
  
  
• Three years ago, in 1999, tax revenue equaled 9 to 10% of Russian gross domestic product. In November 2001, the Russian gross domestic product grew to 16%.
  
  
• The new system greatly reduced the underground economy, where people were paid in goods rather than cash to avoid paying taxes.

Hong Kong has a 15% flat tax on personal income. The Channel Islands of Jersey and Guernsey ask for a 20% flat tax. Other European parties are considering flat taxes in their economic platforms. Go to Bermuda. They have a flat tax, too.

Uncle Sam seems to think we like time-consuming confusion and disorder. Uncle Sam would probably like to keep his huge budget. Perhaps Uncle Sam prefers to flatten forests rather than taxes.

Cora says it all rather blithely, "I think Uncle Sam is just too old, and he doesn't know what he's doing."

Until Next Week,
Linda Goin

BUYandHOLD does not offer or provide any tax or investment advice or opinion regarding the nature, potential, value, suitability or profitability of any particular tax consequence, security, portfolio of securities, transaction or investment strategy. The opinions expressed above are not necessarily those of BUYandHOLD, its officers, directors or its affiliates.