The Case for Capping Income and Revisiting Tax Exemptions

Taxation is a fundamental aspect of any society, serving various purposes from funding government services to ensuring social equity. The current tax structures in many countries often focus on taxing an individual's income. However, the debate about the need for an income cap and the appropriate tax exemptions is gaining traction as a method to ensure a fairer and more sustainable tax system.

Income Tax Thresholds and Revenues

In India, for instance, the tax exemption threshold is set at Rs. 300000 per annum for the financial year 2024-25. Any income earned above this threshold becomes taxable. Additionally, there is a rebate system where up to Rs. 700000 of the income is exempt from tax liability, provided the individual files a return and claims the rebate. This system, while aimed at fairness, requires detailed maintenance of records and compliance from taxpayers.

In the United States, the situation is slightly different. The federal income tax starts to apply beyond a certain threshold, but due to various deductions and credits, many individuals can maintain a middle-class income without having to pay much, or even any, individual income tax. According to the IRS, the standard deduction for the tax year 2023 is $13,850. However, not everyone reaches this threshold, thanks to tax credits and deductions.

Theoretical and Practical Implications

The introduction of an income cap, or in other words, a limit on how much an individual can earn before being subject to progressive tax rates, would require a reevaluation of the current tax framework. At the heart of this debate lies the necessity to ensure that those who benefit the most from society's infrastructure and services also contribute the most in taxes. However, it is also argued that low-income individuals should be exempt from taxes, especially those who rely on government assistance.

Government Funding through the Federal Reserve

A key point to consider is the role of the Federal Reserve in government funding. Unlike popular belief, taxes do not directly fund the federal government. When Congress approves a budget, the Federal Reserve creates a liability record and sends the matching money to the Treasury. The Treasury then distributes this money to government services, which in turn spend it into circulation. This means that taxes are not directly funding the government, but rather ensuring that the budget is balanced and the economy is stable.

How does it work?

Congress approves a budget. The Federal Reserve creates a liability record and injects the corresponding amount of money. The Treasury distributes this money to various government services. The services spend the money into circulation.

This process highlights the fact that the establishment of the Federal Reserve has fundamentally changed how the government is funded and operates. Most of what we are taught about money is misguided because it does not account for the role of the Federal Reserve in creating and managing the nation's money supply.

Optimal Tax Structures and Income Increases

The current system of progressive taxation, where taxes increase as the amount of income grows, is the best available model. However, the focus should be not on the total income but on the increase in income over time. In an ideal tax system, only increases in income would be taxed. This approach would be more equitable and would prevent the rich from profiting excessively from market fluctuations and increases in asset values. Progressive taxes on increases in income would ensure that the wealthiest individuals contribute a larger share of their income, which would in turn help fund social services and reduce inequality.

Today, we are facing a critical juncture in tax policy. The question of whether there should be an income cap, how to design optimal tax structures, and how to ensure that tax exemptions are fair and sustainable are essential issues that need to be addressed. The goal should be to create a tax system that is not only efficient but also just, promoting a stable and equitable society.