Simplicity is key to a fair tax system
Simplicity is key to a fair tax system
By Clive Crook
Copyright The Financial Times Limited 2007
Published: July 25 2007 17:28 | Last updated: July 25 2007 17:28
There is never a good time in America to discuss tax reform. Come the spring, gloom and panic descend. In the throes of the annual tax-preparation ordeal, the prospects of a simpler, fairer system are so remote from the lunatic reality, and the country’s pitiful taxpayers so visibly oppressed and demoralised, that raising the subject seems indelicate. Once the horror of April is over, who in his right mind would want to think about the subject again? This recurring cycle of mass dismay and collective euphoric paralysis is the only way to explain how Congress has been permitted to twist the American tax code, some 20 years after the last great simplification, into its present cruel and unusual condition.
Ronald Reagan’s tax reform of 1986 significantly improved the system. Since then Congress has made a few changes – 15,000 at the last count: new credits, deductions, exemptions, preferences, phase-outs, phase-ins, limits, restrictions and extensions.
According to an expert advisory panel that reported to the president in 2005, Americans spend about 3.5bn hours and $140bn a year on doing their taxes or getting somebody else to. That is roughly $1,000 per family, or enough to pay for the Department of Homeland Security, the Department of State, Nasa, the Department of Housing and Urban Development, the Environmental Protection Agency, the Department of Transportation, the US Congress, the federal court system and all of the federal government’s foreign aid. Simple this system is not.
Nor fair, nor efficient. The code remains moderately progressive – as incomes rise, average tax burdens rise, too – although the current administration’s controversial cuts in income tax rates and in taxes on dividends and capital gains made it less so. But the rate structure, which so preoccupies politicians, is only part of the issue. The system’s very complexity also militates against fairness.
Most low-income families claiming the earned-income tax credit (a subsidy paid to those on low wages) find the rules so daunting that they spend some of their meagre income on a tax preparer; others just forgo the benefit. Low and middle-income taxpayers are more likely than those on higher incomes to choose the standard deduction, rather than selecting “itemised deductions” from the code’s long list. As a result, preferences created to advance social goals – such as the vastly expensive deduction for mortgage interest, intended to extend home ownership – mainly cut the taxes of the higher paid. The fiscal cost of tax reliefs for employer-provided health insurance is $200bn a year, but those on the lowest incomes are unlikely to be offered that benefit in the first place and so gain nothing.
As for efficiency, the code subsidises debt and taxes saving twice, unless you resort to an array of complex tax-preferred instruments, which even professional advisers appear not to understand. Companies face big incentives to borrow rather than issue stock. Interest is deductible; earnings paid to shareholders are taxed first as profits and again as dividends. Putting the method of financing to one side, investments in different kinds of physical capital are arbitrarily taxed at widely varying rates.
The only good thing to be said for this fiscal atrocity is that a crisis is coming. In an attempt to claw back tax breaks of its own devising, which had allowed those on very high incomes to pay little in taxes, Congress introduced the Alternative Minimum Tax – a parallel complex tax code, with faults all its own, aimed at making the rich pay more. This tax is increasingly catching middle-income earners in its maw, which is arousing political demands for a costly fix. At the same time, President George W. Bush’s tax cuts are mostly due to expire in the next few years, further destabilising the system.
It will fall to Democrats to repair this comprehensively broken code – which they can do, as long as they are willing to think big. Higher marginal rates on top personal incomes, higher taxes on capital gains and dividends, and higher taxes on profits would all make the system more progressive, but at the great cost (if nothing else were done) of aggravating the worst anti-growth distortions and further discouraging saving and investment. The best way to make the system more progressive – a worthy goal, to be sure – is to simplify it violently. Consolidate the reliefs for saving. Abolish as many of the code’s other preferences and deductions as possible. Use the proceeds to cut payroll taxes, raise the standard deduction and pay for a simpler and more generous low-wage subsidy.
Precisely because the present system is so dreadful, it is easy to contemplate one that is much fairer, much simpler and much more efficient, all at the same time. And thanks to the metastasising AMT, the current mess is unsustainable, to boot. What an opportunity.
Eradicating those treasured deductions is a enormous political challenge, needless to say. But it can be done. (British politicians used to think that mortgage tax relief was untouchable; it no longer exists.) Democrats need to weigh the difficulty against the prize. An assault on the complexity of the system is an assault on the unfairness of the system. Complexity serves the rich: they can game the complications. And a simpler system would let everybody look forward to spring. Is that so much to ask?
clive.crook@gmail.com
By Clive Crook
Copyright The Financial Times Limited 2007
Published: July 25 2007 17:28 | Last updated: July 25 2007 17:28
There is never a good time in America to discuss tax reform. Come the spring, gloom and panic descend. In the throes of the annual tax-preparation ordeal, the prospects of a simpler, fairer system are so remote from the lunatic reality, and the country’s pitiful taxpayers so visibly oppressed and demoralised, that raising the subject seems indelicate. Once the horror of April is over, who in his right mind would want to think about the subject again? This recurring cycle of mass dismay and collective euphoric paralysis is the only way to explain how Congress has been permitted to twist the American tax code, some 20 years after the last great simplification, into its present cruel and unusual condition.
Ronald Reagan’s tax reform of 1986 significantly improved the system. Since then Congress has made a few changes – 15,000 at the last count: new credits, deductions, exemptions, preferences, phase-outs, phase-ins, limits, restrictions and extensions.
According to an expert advisory panel that reported to the president in 2005, Americans spend about 3.5bn hours and $140bn a year on doing their taxes or getting somebody else to. That is roughly $1,000 per family, or enough to pay for the Department of Homeland Security, the Department of State, Nasa, the Department of Housing and Urban Development, the Environmental Protection Agency, the Department of Transportation, the US Congress, the federal court system and all of the federal government’s foreign aid. Simple this system is not.
Nor fair, nor efficient. The code remains moderately progressive – as incomes rise, average tax burdens rise, too – although the current administration’s controversial cuts in income tax rates and in taxes on dividends and capital gains made it less so. But the rate structure, which so preoccupies politicians, is only part of the issue. The system’s very complexity also militates against fairness.
Most low-income families claiming the earned-income tax credit (a subsidy paid to those on low wages) find the rules so daunting that they spend some of their meagre income on a tax preparer; others just forgo the benefit. Low and middle-income taxpayers are more likely than those on higher incomes to choose the standard deduction, rather than selecting “itemised deductions” from the code’s long list. As a result, preferences created to advance social goals – such as the vastly expensive deduction for mortgage interest, intended to extend home ownership – mainly cut the taxes of the higher paid. The fiscal cost of tax reliefs for employer-provided health insurance is $200bn a year, but those on the lowest incomes are unlikely to be offered that benefit in the first place and so gain nothing.
As for efficiency, the code subsidises debt and taxes saving twice, unless you resort to an array of complex tax-preferred instruments, which even professional advisers appear not to understand. Companies face big incentives to borrow rather than issue stock. Interest is deductible; earnings paid to shareholders are taxed first as profits and again as dividends. Putting the method of financing to one side, investments in different kinds of physical capital are arbitrarily taxed at widely varying rates.
The only good thing to be said for this fiscal atrocity is that a crisis is coming. In an attempt to claw back tax breaks of its own devising, which had allowed those on very high incomes to pay little in taxes, Congress introduced the Alternative Minimum Tax – a parallel complex tax code, with faults all its own, aimed at making the rich pay more. This tax is increasingly catching middle-income earners in its maw, which is arousing political demands for a costly fix. At the same time, President George W. Bush’s tax cuts are mostly due to expire in the next few years, further destabilising the system.
It will fall to Democrats to repair this comprehensively broken code – which they can do, as long as they are willing to think big. Higher marginal rates on top personal incomes, higher taxes on capital gains and dividends, and higher taxes on profits would all make the system more progressive, but at the great cost (if nothing else were done) of aggravating the worst anti-growth distortions and further discouraging saving and investment. The best way to make the system more progressive – a worthy goal, to be sure – is to simplify it violently. Consolidate the reliefs for saving. Abolish as many of the code’s other preferences and deductions as possible. Use the proceeds to cut payroll taxes, raise the standard deduction and pay for a simpler and more generous low-wage subsidy.
Precisely because the present system is so dreadful, it is easy to contemplate one that is much fairer, much simpler and much more efficient, all at the same time. And thanks to the metastasising AMT, the current mess is unsustainable, to boot. What an opportunity.
Eradicating those treasured deductions is a enormous political challenge, needless to say. But it can be done. (British politicians used to think that mortgage tax relief was untouchable; it no longer exists.) Democrats need to weigh the difficulty against the prize. An assault on the complexity of the system is an assault on the unfairness of the system. Complexity serves the rich: they can game the complications. And a simpler system would let everybody look forward to spring. Is that so much to ask?
clive.crook@gmail.com
posted by Carlos T Mock at 9:24 AM
0 Comments:
Post a Comment
<< Home