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A Fine Mess: A Global Quest for a Simpler, Fairer, and More Efficient Tax Code

14 Jun 2017 11:35 AM | Deleted user

By Daniel Zuchegno


Speaker: T.R. Reid

At The Washington Post, T.R. Reid covered Congress and four presidential campaigns, served as the paper's bureau chief in Tokyo and London, and has reported from 4 dozen countries on five continents. T. R. Reid has written ten books in English and three in Japanese, and translated one book from the Japanese. His 2009 book "The Healing of America" became a national best-seller. PBS Frontline made two documentaries, "Sick Around the World" and "India--A Second Opinion" following Reid as he did the reporting for that book. T. R. Reid's newest book: "A Fine Mess -- A Global Quest for a Fairer, Simpler, and More Efficient Tax Code" was published in April, 2017. It suggest what the U.S. should and should not do as Congress embarks on a major effort at reforming our federal tax system. T. R. Reid has made documentary films for National Geographic Television, PBS, and the A&E Network. His latest PBS film was "U.S. Health Care: The Good News," which is being broadcast by PBS affiliates around the country. Reid is Chair of the Board of the Colorado Coalition for the Homeless, has served as Kai-cho, or President, of the Japan-America Society of Colorado, Chairman of the Colorado Foundation for Universal Health Care, and on the boards of Princeton University and several other community and national organizations.


While it is common to complain about taxes and believe that we in the United States are overly taxed, the average single American pays about 25 percent of their paycheck for income tax and social safety taxes — which in the U.S. include programs like Social Security and unemployment insurance.  But when compared to other high-income nations, Americans typically are taxed on the lower end of the scale: the U.S. ranks No. 25 out of the 34 developed nations according to the Organization for Economic Cooperation and Development, or OECD.  Looked at in a different way,  the US total tax burden, Total US tax revenue as a percent of GDP is 26 percent, significantly below the 34 percent average for developed countries  While many of our taxes are lower than those of other nations, the US corporate tax is an exception.  Out of the 34 countries in the OECD, America ranks first with a 39.1 percent corporate tax rate, compared to an OECD average of 24.1 percent.


The concept of tax efficiency implies the minimization of the cost of complying with the tax code by reducing its administrative burden, of both the tax agency and the tax payer, and minimizing any distortions in the economy caused by the tax.  In other words, we don’t want the tax to change any specific behavior from what would have occurred if there were no tax. Tax equity is the principle that taxes should be fair.


There are, however, several criteria for determining what is fair. The benefits principle states that people should pay taxes based on the benefits that they receive from government services. For instance, taxes on gasoline are used to build roads and bridges. The more you drive, the more gasoline you use, the more taxes you pay. The more you drive, the more benefits you receive from good roads and bridges. Seems simple enough, and fair. What about income taxes?  Taxes on income and investments are a bit more complex, and we need to look at several additional concepts. One concept is the ability-to-pay principle.   Ability-to-pay introduces two additional ideas to complete the discussion: vertical equity and horizontal equity.Vertical equity is the principle that people with higher incomes should pay more taxes, as they have a greater ability to pay. Horizontal equity is the principle that people with equal abilities to pay should pay the same amount of taxes. A common application of this principle is the provision for the numerous deductions and tax credits available for people who have children, allowing them to pay less tax for a given level of income.

 

One further concept is the idea that there is a declining marginal utility of money.  Anyone who has ever gotten sick after eating the fifth piece of double chocolate fudge at any of the shops in Estes Park is very familiar with the concept of diminishing marginal utility or diminishing marginal value.  It is argued by my fellow economists that money, similar to fudge, has a diminishing marginal utility or value as the amount of money one earns or owns increases. It is generally held that those with higher income and wealth should pay more taxes, based on the benefits principle, the ability-to-pay principle, and the marginal utility principle. The benefits principle applies because the wealthy profit more from police and fire protection, the court system, and national defense, since they have more to protect.  Based on the ability-to-pay and marginal utility principles, the wealthy should pay a greater percentage of their income, since any given percentage of income is more valuable to the poor than to the wealthy.  The more difficult question is how much more.


During his talk, Mr. Reid asked if anyone believed the current US tax system was as simple as it can be and if it is fair and efficient.  As Mr. Reid pointed out, all three parts of the questions are very inter-related. A few statistics offer perspective on our tax code. It's estimated that taxpayers spend $19.6 billion on compliance efforts each year related to the estate and gift tax: the IRS expects to collect just $20 billion from the tax in 2016. Recall that one aspect of an efficient tax system is that you minimize the cost of collecting a given amount of tax revenue.


Americans spent more than 8.9 billion hours complying with IRS tax filing requirements in 2016. To put that in context, that works out to 222,500,000 full work weeks (assuming a standard 40 hour work week). You'd have to work 4,278,846 years straight to hit those kinds of numbers.  All in all, tax compliance will cost the U.S. economy $409 billion this year. (That's the word out of The Tax Foundation). It should be noted that these costs are substantially higher than most any other developed nation.


The length and complexity of the US tax code is the major cause of the difficulty of compliance.  Our Tax Code in 1955, the Internal Revenue Code, was 409,000 words long. Today, it's about 2.4 million words long (depending on who you ask): almost six times as long as it was in 1955 and almost twice as long as in 1985.

 Why all the complexity?   Congress uses the tax code to undertake social and economic engineering, sometimes on their own accord, other times, at the behest of strong lobbying groups.  Besides trying to promote or limit certain activities, much of the complexity of the tax code results from Congress giving preferential treatment to particular groups. This preferential treatment is provided not only in the way the tax is basically structured, but also in the form of tax loopholes which allows taxpayers to take advantage of the laws.  Other additions to the tax code cater to a variety of special lobbying interests. For instance, Boeing saved $158 million in 2010 through the research-and-experimentation tax credit and ConocoPhillips saved $82 million through the Domestic Production Activities Deduction. There is a separate tax on fuel used in commercial transportation on inland waterways, as well as a special surtax on fuel used in aircraft which are part of a fractional ownership program . There is a special designation on income earned from the ownership of natural resources, income as a deferred compensation, income from investment companies, and banking institutions. 


Perhaps the largest designation of income by the IRS is the distinction between wage income and non-wage or investment income. Working or wage income is taxed the most, investment/financial income is taxed considerably less, and gratuitous transfers are taxed the least, if they are even taxed at all.  On working or wage income, there is an increasing marginal tax rate and an employment/payroll tax, while non-wage income is treated differently and taxed at different rates. For instance, the 12.4% Social Security payroll tax is applied only to income at or below the inflation-adjusted wage base limit for Social Security, which, in 2015, was $118,500.  No employment taxes were applied to investment income — which is why they were called employment taxes, only assessed on working income.  In 2013, a new net investment income tax was enacted, otherwise known as the Medicare surcharge, applying a 3.8% Medicare tax on investment income earned by people with an income of at least $200,000 per year ($250,000 for a married couple).  A movement toward more equity at the expense of simplicity. 


Other attempts at equity such as aid to families with dependent children, health cost allowances, mortgage deductions, allowances for charitable contributions,and more, are generally well intentioned, but add to the complexity of our tax code.  It seems the complexity of our tax code is a series of piecemeal attempts over time to impact specific behavior and/or attain a greater degree of efficiency and equity.  Regardless of the cause of the complexity, one more thing is certain, the more complex and difficult it is to pay taxes, the more revenue the tax filing industry earns.


Is there any way to simplify our tax code?  Mr. Reid argues yes, and addressed re-occurring attempts to do so, talking in depth about one such attempt, the flat tax, an income tax system where everyone pays the same percent of their income in taxes.


However, given our current distribution of income in the United States, there isn’t a flat percentage rate for taxes that would be able to generate needed revenues without effectively raising tax rates for poorer income earners. Mr. Reid proposed an alternative to the flat tax; an increasing marginal tax rate, i.e. a progressive tax, with few or essentially no deductions or credits, that applies to all income, whether it be working, investment, or inherited income. With essentially no exceptions or “loopholes”, rates could be much lower than they are currently, with less of a burden on everyone yet yielding more tax revenue. Is tax reform a reasonable expectation?
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