This is the fourth in a series of posts about priorities for Congress and President Obama in his second term.
Priority #1, The Fiscal Cliff:
http://debatablypolitical.blogspot.com/2012/11/priorities-for-obamas-second-term-1.html
Priority #2, Reducing the Federal Deficit
http://debatablypolitical.blogspot.com/2012/12/priorities-for-obamas-second-term-2.html
Priority #3, Immigration Reform:
---------------
Priority #1, The Fiscal Cliff:
http://debatablypolitical.blogspot.com/2012/11/priorities-for-obamas-second-term-1.html
Priority #2, Reducing the Federal Deficit
http://debatablypolitical.blogspot.com/2012/12/priorities-for-obamas-second-term-2.html
Priority #3, Immigration Reform:
---------------
Priority #4, Tax Reform
The fourth priority for the new Obama administration should
be tax reform. This is an issue that the
Republicans got right. The 2012
Republican platform called for entirely scrapping the Federal Income tax code,
and starting over from a clean slate.
Tax reform is necessarily complex, because the tax code is complex. The political fight will be difficult,
because the tax code has penetrated every aspect of American life. For every provision that might be changed,
there will be winners and losers, and it will be difficult to make changes
without making enemies.
The amount of tax collected in the United States is low by comparison to other countries of the OECD. Overall, the United States collects 24.8 percent of GNP in all taxes, including income, payroll, corporate, excise, and state and local taxes. The United States ranked 2nd lowest of 34 OECD countries in Federal tax collected as a percentage of GDP (9.4) in 2010, and 3rd lowest in total tax collected. However, this blog post is not about the amount of tax collected, but rather about the complexity and economic losses caused by our system of taxes.
A report by the GAO (Government Accountability Office) found that costs to society or our tax system are “large”, but highly uncertain. According to the report, the U.S. tax system may cost society 2% to 5% of GDP. This is huge.
A report by the GAO (Government Accountability Office) found that costs to society or our tax system are “large”, but highly uncertain. According to the report, the U.S. tax system may cost society 2% to 5% of GDP. This is huge.
The goals of tax reform should be straightforward. The tax system should be simplified in the
interest of fairness and transparency. The new
tax system should reduce economic distortions which presently cause losses of
2% to 5% of GDP. The new tax system should extend
participation to all wage earners, strengthen successful businesses, reduce required record-keeping, and eliminate the motivation for costly tax-avoidance schemes.
Here are the basic areas needing reform.
1. Simplify the US
income tax.
2. Gradually eliminate many
deductions.
3. Extend income tax
to all wage-earners, while reducing Social Security and Medicare payroll taxes
to keep tax burden on lower-income tax-payers constant.
4. Extend Social
Security tax to investment income.
5. Simplify the Corporate Income Tax, and reduce tax rates.
6. Reduce the Estate Tax rate.
7. Eliminate Gift
Tax, but require payment of Capital Gains upon transfer to another individual.
1. Simplify the US
income tax code
A)
The United States Income Tax Code now amounts to 73,000 pages. Nobody understands it.
B)
Employees of the Internal Revenue Service do not understand the tax
code. An audit by the IRS in 2008 showed
that its employees provided incorrect tax advice to tax-payers 9% of the
time. The GAO (General Accountability
Office) previously found that the IRS error rate was 12% to 25%. Of course, the tax-payer is liable for any
errors made on his return, regardless of the advice he may have received from
the IRS.
C)
More than 1.2 million people are employed to assist individuals in
preparing tax returns. Sixty-two percent of tax returns (about 80
million tax returns) are prepared by professionals. An audit by the GAO found that 12 percent of professionally prepared returns contained reporting errors, and 1 percent contained mathematical errors. These
workers could be doing something of greater value to society, but the potential
productivity of these workers is wasted because of the complexity of the tax
system.
D)
A 2005 report by the General Accountability
Office divided tax costs into compliance (time and effort to complete the tax
returns) and efficiency (changes in work, savings, investment and consumption
behavior). The report cited the lowest estimates of the
cost to individuals and businesses to prepare tax returns at $107 billion
(about 1% of GDP). Other studies
estimate compliance costs to be 50% larger.
Estimates for efficiency losses to the economy range from 2% to 5% of
GDP (as of the mid-1990s).
E)
The complexity of the tax code contributes to tax cheating and lost
revenue. The system is so complex that
there is a common feeling that other people, particularly the wealthy, are not
paying their fair share. This perception
contributes to an attitude that cheating on taxes is justified, in order to pay
only as much as others are paying.
2. Eliminate many
deductions.
There are seventy-three tax breaks
which each reduce tax collections by over a billion dollars. The largest of these tax breaks is the
exclusion of employer-paid health benefits from taxation, which costs about 174
billion dollars each year. These breaks
reduce tax collections by about $1.2 trillion per year; eliminating these tax
breaks would balance the Federal budget without any other action.
These tax breaks are deeply
ingrained in American culture, and are a significant part of citizens’
individual tax planning. Changing or
eliminating these breaks will be difficult, but a process of phasing out these
deductions should begin, as part of the general simplification of the tax code.
The primary function of the tax
code should be to fund the government, not for social engineering. Congress’ extensive use of taxes for social
engineering is impairing the primary function of the tax system.
3. Extend income tax
to all wage-earners. Reduce Social
Security percentage to keep tax burden on lower-income stable. Every citizen needs to have “skin in the
game”, i.e. a vested interest in how US government dollars are spent.
During the 2012 election, much
attention was given to Mitt Romney’s complaint (given privately, to roomful of rich donors) that 47% of US wage-earners pay no income tax. Romney’s statement implied regarding these
low wage-earners as parasites on the system.
Interestingly, most of the tax breaks exempting the 47% from income
taxes were originally passed as initiatives of Republican presidents. It should be noted that the 47% are already
paying substantial payroll taxes to support Medicare and Social Security.
Fundamentally, Romney is correct. It is not right
that nearly half of our citizens pay no income tax.
Everyone should pay some Federal tax, to take an “ownership” interest
in government. We should not have a
disinterested class of people who have no direct stake in government
finances. Citizens should all feel
responsible for some part of financing the government, and to feel some pain
about government spending, to motivate interest in voting and spending issues. It is easy to be disinterested when the government is spending somebody else's money.
Every wage-earner should pay some
Federal income tax. Payroll taxes should
be reduced (or incorporated into income tax) in order to extend Federal tax to
all workers, without imposing an additional burden.
4. Extend Social
Security tax to investment income.
I see no reason why investment
income (interest, dividends and capital gains) should be exempt from Social
Security and Medicare taxes. Social
Security and Medicare require additional tax revenue to remain solvent. It is not fair to make wage-earners carry
the entire burden of elder care and the social safety net. Those who earn money through investments
should carry at least an equal burden.
5. Simplify the Corporate Income Tax, and reduce tax rates.
Federal corporate income tax rates
nominally range from 15% to 35% percent.
Additional state taxes are also levied on corporate income. The United States ranks 17th of
34 countries in the OECD in terms of corporate tax revenue as a percent of
GDP.
Corporate income taxes, like
individual income taxes, are unnecessarily complex. There are fourteen corporate tax breaks
costing over one billion dollars are year in lost revenue. These tax breaks encourage certain economic
goals designated by congress, but sometimes produce market distortions and
unintended consequences. An example is
the tax break given for the production ethanol fuels. Since production of corn-based ethanol
consumes nearly as much energy as it produces, the tax break encourages
misallocation of resources, and makes food scarcer and more expensive. Simplification of the corporate tax code would
reduce economic distortions, and provide a fairer playing field for companies.
Corporate income tax acts as a drag
on the most successful companies, and helps to prop up unsuccessful
companies. Corporate income tax deprives
successful companies of the capital needed to expand, and reduces the
competitive margin between successful and unsuccessful companies. Reducing corporate income tax would encourage
successful companies to expand, and help them succeed in global markets.
6. Reduce the Estate Tax rate.
The United States Estate Tax (pejoratively
termed “the Death tax” by opponents), is among the most contentious aspects of
the tax system. A substantial reduction
in the Estate Tax rate is recommended.
It might be reasonable to peg the estate tax rate to the long-term
capital gains rate, and accompany the transfer of title of assets to a step-up
in the cost basis of those assets to the market value at the time of transfer.
The amount of money collected by
the estate tax is relatively trivial, yet citizens incur substantial costs and
undue anxiety worrying over this tax. It
is clear that citizens spend a great deal of money avoiding the tax, but it is
difficult to find unbiased data about how much.
Tax avoidance measures through wills and trusts also introduce economic
costs. A 1999 study cited by the GAO
showed that the estate tax resulted in efficiency costs to the economy of $38
billion, as a result of distortions in consumer choices. By comparison, historically the highest
amount ever collected by the estate tax was $ 37 billion.
The tax rate above the minimum
exclusion is 2nd highest among industrialized countries at 55%. About half of those countries have no estate
tax, and the median of the remainder is 20%.
Only Japan has a higher tax rate, at 70%. The exclusion amount is currently $5 million,
but will revert to $1 million on January 1, 2013, pending any revision.
In my view, the Federal government
should take a lesson from Henry Ford.
Ford priced his cars as low as possible, and made higher profits by
selling more cars. At 55%, the estate
tax is too high. People are loath to pay
this level of tax, and will expend considerable time and money to avoid it. But a less confiscatory tax would meet with
greater compliance, produce less economic costs and distortions, and might
produce greater revenue for the government.
A further step would be to prohibit
tax-avoiding trusts and trust provisions.
If Congress has decided, for the good of society, that citizens should
pay estate tax, then our laws should prevent avoidance of that tax. It is absurd to permit legal manipulations
which evade the intent of our tax laws.
7. Eliminate Gift
Tax, but require payment of Capital Gains upon transfer to another individual.
The Gift Tax is closely tied to the
Estate tax. Essentially, the Gift Tax is
simply intended to prevent avoidance of the Estate Tax by early transfer of
assets to heirs. The Gift Tax is only incurred on large
transfers of wealth, but requires life-long record keeping. A better solution would be to peg the Gift
Tax to the Capital Gains tax, and step-up the cost basis for assets, exactly as
suggested for the Estate Tax.
--------
References:
Costs of the US Tax
System
In 2005, the GAO reported that costs for tax compliance and
tax efficiency are “large”. Estimates
are reported in the range of 1% to 1.5% of GDP for compliance; and economic
efficiency costs are reported in the range of 2% to 5% of GDP,
(mid-1990s). No better data was
available.
ICB (Treasury Department) estimated that individuals,
businesses and exempt organizations spent a total of 6.4 billion man-hours
filling out tax forms. Others do not
trust these estimates.
Compliance costs are reported over $100 billion or about 1%
of GDP; this is given as the low-end of the uncertainty range.
Interactive OECD comparative tables about taxes as
percentage of GDP.
US 2010 total tax: 24.8 percent of GDP, 3rd
lowest of 34 OECD countries
US 2010 federal tax:
9.4 percent of GDP, 2nd lowest of 34 OECD countries
Federal 9.4 percent,
State 5.1 percent, Local, 4.0
percent, Social Security 6.4
percent (of GDP)
US 17th of 34 in Corporate Tax collected (as a
percentage of GNP) in 2010.
General information.
Over 70,000 pages in the US tax code, 2010
IRS Errors and Tax
Preparer Errors
1997 article; IRS advice was incorrect 12% of the time by
telephone, 40% of the time in person.
IRS advice wrong 25% of the time.
More about IRS errors.
62 percent of tax returns (80 million) are prepared by paid
tax preparers (2005).
42 percent of test returns resulted in material errors (of
$1500 per return).
12 percent of returns by professional preparers contain
reporting errors; 1 percent contain math errors.
10 percent of self-prepared returns contain reporting
errors; 5 percent contain math errors.
In a GAO audit of paid tax preparers, the professions
arrived at the correct answer on only 2 out of 19 tax returns.
Accuracy at IRS walk-in assistance centers improved from 85%
in 2008 to 91% in 2010. Assistance
centers are staffed by volunteers.
Accuracy at call-in centers is not reported. Only
76% of callers seeking live help receive service.
Costs of Tax
Preparation
About 1.2 million tax preparers in the US.
Cost of tax preparation in the United States is $100 billion
to $150 billion.
“Understanding the
magnitude of these additional costs is important because every dollar spent on
compliance and lost due to inefficiency represents a dollar that society could
have spent for other purposes.”
Details of 172 tax breaks for individuals and
corporations. Seventy three tax breaks
account for more than one billion dollars each of lost tax revenue.
Estate Tax
Politically biased piece in favor of estate tax. Costs of compliance with Estate Tax estimated
at 7% of tax collected. Cost of
avoidance is belittled, but not quantified.
Politically biased piece, in opposition to estate tax. Large costs are claimed for estate tax. Maximum ever collected by estate tax is $37
billion, in constant dollars.
Cost of compliance with Income tax is estimated at 14.5% of
tax collected; cost of compliance with estate tax is estimated at 7% of tax
collected.
At 55%, the United States Estate tax is second only to Japan
in a list of 50 industrialized countries.
About half of those countries have no estate tax, and the
median of the remainder is 20%.
Without new legislation, estate taxes will revert to 55% of
the value of estates greater than $1 million.
It is expected that the exemption amount will be raised by new
legislation. An exemption of $5 million
was put in place in 2010.
One study cited estimated efficiency costs of the Estate tax
at $38 billion in 1999.
The most tax ever collected by the estate tax was $37
billion, in 2000.